Exchange risk management at agribank

ề Đ án Ki nh EXCHANGE RISK MANAGEMENT AT AGRIBANK Student’s name: Quan Thi Hanh Mai Class: Advanced Finance Intake:50 Internship guide: Ms.Nguyen To Huong (Head of risk mangement) Supervisor: Dang Ngoc Duc, PhD Hanoi, 2012 tế BACHELOR’S THESIS IN FINANCE c ***************************** ố qu ADVANCED EDUCATIONAL PROGRAM tế NATIONAL ECONOMICS UNIVERSITY ề Đ án Ki nh tế ố qu ACKNOWLEDGEMENT c tế This thesis owes its existence to the help, support, and inspiration of many people In the first place, I would like to express my sincere appreciation and gratitude to my instructor Ph.D Dang Ngoc Duc for his support and encouragement through obstacles in the completion of this paper Besides, I am heartily thankful to Ms Nguyen To Huong – Head of risk management department and Mr Vu Gia Hung – Head of FX trading department of Agribank for giving me the great opportunity to work there And also my thanks to all the staffs of both departments who shared and showed me a lot of FX trading experiences in practice Last but not least, I offer my regards and blessings to my family for continuous and unconditional support of all my undertakings, scholastic and otherwise that help me a lot accomplish my research ề Đ án Ki nh tế ố qu ABSTRACT c tế The paper explores the foreign currency trading activities in commercial banks and penetrates the tactics to manage exchange risk in those transactions underlying using derivatives instruments The purposes of this thesis are to understand the current situation of currency trading in commercial banks and give out some solutions to enhance exchange risk management in FX market My thesis’s idea comes from the need to apprehend the actual FX trading in interbank market via Electronics Brokering Services (EBS) or Reuter Dealings and risk management in FX transactions This paper includes introduction, general summary, report of Agribank, problem findings and recommendations To conduct the research, I analyzed and comprehended all the theories and the facts that the bank applied to have an overview of FX market and foreign currency trading in commercial bank Moreover, I spent a lot of time at FX trading department to observe the real trade in Reuter Dealings And I also exchanged and discussed methodologies and experiences to take profit and stop loss in the FX market with the staffs in there According to problem findings that I figured out, I will draw my own conclusions to strengthen the risk management system for commercial banks Because of time limitation, available sources and my ability, I just described and evaluated the current situation and the problems in Agribank for reference Hopefully, the paper could be helpful for anyone who wants to understand the working mechanism of commercial bank in terms of forex trading and risk management in FX market ề Đ án Ki nh tế ố qu TABLE OF CONTENTS c tế ACKNOWLEDGMENT ABSTRACT TABLE OF CONTENTS LIST OF ABBREVIATION LIST OF CHARTS AND TABLES CHAPTER I: INTRODUCTION .1 1.1 Rationale 1.2 Research objective 1.3 Research methodology 1.4 Scope of researches 1.5 Structure of thesis CHAPTER II: THEORETICAL BACKGROUND OF EXCHANGE RISK IN FX MARKET AT COMMERCIAL BANK 2.1 Overview of FX market 2.1.1 Definitions of FX market 2.1.2 FX market structure 2.1.3 Operation of FX market 2.1.3.1 Traded currencies 2.1.3.2 Market participants 10 2.1.3.3 Banking operations 12 2.2 Exchange risk in foreign currency trading in commercial banks 14 2.2.1 Banking involved risks in FX market 14 2.2.1.1 Cash flow position and interest risk 14 2.2.1.2 Foreign exchange position and exchange risk 15 2.2.2 Foreign exchange risk in commercial banks 17 ề Đ án Ki nh tế 2.2.3 Consequences of exchange risk .19 ố qu c 2.2.4 Hedge against exchange risk 19 tế 2.2.4.1 Matching foreign currency assets and liabilities 19 2.2.4.2 Using derivatives .20 2.2.4.3 Diversification of foreign asset-liability portfolio 20 2.2.4.4 Golden rules in FX market 20 CHAPTER III: CURRENT SITUATION IN FOREIGN CURRENCY TRADING AND ECHANGE RISK MANAGEMENT AT AGRIBANK .22 3.1 Introduction to Agriculture bank 22 3.2 Organization structure 25 3.3 Operation results of Agribank in 2010 – 2011 27 3.3.1 Financial highlights .27 3.3.2 Mobilizing capitals 31 3.3.3 Lending activities 32 3.3.4 Payment activities 32 3.3.5 FX trading activities 34 3.4 Current situation in exchange risk management at Agribank 35 3.4.1 Introduction to FX trading department 35 3.4.2 Foreign exchange products of FX trading department 36 3.4.2.1 Foreign exchange spot .37 3.4.2.2 Forward contract 39 3.4.2.3 Swap contract 39 3.4.2.4 Option contract 40 3.4.3 Performance of foreign currency trading activities in Agribank 40 3.4.3.1 Current situation 40 3.4.3.2 Transactions by types of customers 42 3.4.3.3 Transactions by types of currencies 44 ề Đ án Ki nh tế 3.4.3.4 Transactions by types of FX products .45 ố qu c 3.4.4 Risk management applied in Agribank 47 tế 3.4.4.1 Using FX position limits (risk management department) 47 3.4.4.2 Using derivatives (FX trading department) 49 3.4.5 Evaluation the effectiveness of exchange risk management 51 3.4.5.1 Achievements 51 3.4.5.2 Limitations and reasons 52 CHAPTER IV: SOLUTIONS AND RECOMMENDATIONS 54 4.1 Development trend of currency trading at Agribank in the future .54 4.2 Solutions to enhance exchange risk management in Agribank 55 4.2.1 For risk management department 55 4.2.2 For FX trading department 57 4.2.3 Using modern technology and opening training courses .58 4.2.4 Diversification in currency trading 59 4.2.5 Using orders 60 4.2.6 Forecast exchange rate movement 62 4.2.6.1 Fundamental analysis 62 4.2.6.2 Technical analysis 64 4.2.6.3 Sentiment analysis 65 4.3 Recommendation to SBV 66 CHAPTER V: CONCLUSION .71 APPENDIX 72 REFERENCES ề Đ án Ki nh tế ố qu LIST OF ABBREVIATION c tế Agribank Vietnam bank for Agriculture Rural Development AUD Australia Dollar CAD Canadian Dollar CHF Swiss France EBS Electronics Brokering Services ECN Electronics Communications Network EUR European FX or forex Foreign exchange GBP Great Britain Pound JPY Japan Yen NZD New Zealand Dollar LLC Limited Liability Company OTC Over the Counter SBV State Bank of Vietnam SWIFT Society for Worldwide Interbank Financial Telecommunications USD US Dollar Vinaforex Vietnam foreign exchange market VND Vietnam Dong WTO World Trade Organization ề Đ án Ki nh tế ố qu LIST OF CHARTS c tế Chart 2.1: Average Trading Volume 2010 Chart 2.2: Role of commercial banks in FX Chart 2.3: Decentralized FX Market Chart 2.4: FX Market Hierarchies .8 Chart 2.5: Relation amongst market participants in FX market 12 Chart 3.1: Organization Structure 25 Chart 3.2: Total assets and change rate 29 Chart 3.3: Bottom line of Agribank 30 Chart 3.4: Growth of fund resources period 2008 - 2011 31 Chart 3.5: Breakdown of fund resources in 2011 .31 Chart 3.6: Loans structure 2011 32 Chart 3.7: International payment volumes 33 Chart 3.8: Gain/loss from FX trading 34 Chart 3.9: Organization Structure of FX trading department .35 Chart 3.10: Transactions by types of currencies 45 Chart 3.11: Transactions by types of FX products .46 Chart 3.12: Risk matrix associated with derivatives instruments .50 Chart 4.1: Support and resistance trend line .65 Chart 4.2: Exchange rate and FX reserve in 2011 66 ề Đ án Ki nh tế ố qu LIST OF TABLES c tế Table 2.1: Major Currencies Table 2.2: Major Currencies Pairs 10 Table 2.3: Example of cash flow position at the end of trading day (t) 15 Table 2.4: Example of exchange position of currency F and exchange risk .16 Table 2.5: Money market verses FX market .17 Table 2.6: Golden rules in FX market 21 Table 3.1: Specific goals in 2011 29 Table 3.2: Exchange rate of currency in Operating Centre 37 Table 3.3: Live price in Reuters 38 Table 3.4: Outright Forward Rates between VND and USD 39 Table 3.5: Total foreign currency trading converted to USD .41 Table 3.6: Structure of buying foreign currency by types of customers .42 Table 3.7: Structure of selling foreign currency by types of customers .42 Table 4.1: Business result of spot transactions 56 Table 4.2: Business result of forward transactions 57 ề Đ án Ki nh ố qu and it is a necessary process for development of particular country Integrating in the WTO since 2007, Vietnam is step by step expanding in international transactions, foreign trades, and global activities As the linkage between domestic economy and the rest of the world, FX market plays an important role in controlling and balancing the foreign currency in the economy, and supporting for export and import companies Recently, Vietnam foreign exchange market (VinaFX) is shaping and developing gradually Even in the very first step, VinaFX has created a platform for all commercial banks to operate FX trading transactions Inevitably, these transactions cope with a lot of risks that could be harm for commercial banks, especially the exchange risk Because our market is young and fresh, exchange rate risk management research will be useful for better performance of commercial banks to out of the fog in FX market 1.2 Research objectives The paper was conducted for my first objective is to comprehend the operation of VinaFX and currency trading of commercial banks in interbank market Moreover, I want to take a look insight the way to trade currency and derivatives at FX trading department According to the understanding of working mechanism of the market, I can find out challenges and obstacles in FX transactions that lead to the need of intensive exchange risk management Taking the case of Agribank, I aim to penetrate not only reality but also to learn any problems in Agribank’s exchange risk management system Via my study, definitely, I prefer to give out some solutions to overcome concerned issues at Agribank and recommendations for SBV in action tế Without a doubt, internationalization is becoming a stronger and stronger trend c 1.1 Rationale tế CHAPTER I: INTRODUCTION ề Đ án Ki nh tế of the dollar When the European Central Bank (ECB) increased interest rate savings, ố qu c the opposite happens, the EUR went up tế  The U.S trade deficit (imports greater than exports) and the budget deficit (spending more than revenues) has pushed down the value of the dollar lower When imports exceed exports Europe, the euro weakened  GBP / USD The UK is a country whose economy ranks the 4th largest in the world with a GDP of just over trillion GBP/USD is also one of the most exciting and volatile currency pair in the world As the currency pair has a long history, the intense volatility of this currency pair usually move hundreds of pips at a time, the trader will have many opportunities for any period of time Shift average levels for this pair are usually over 150 pips The best time to trade this pair is from 3:00 am until 10:00 am EST Trade tricks:  UK housing market is a factor that leading to manifestation of inflation Status of GBP homes emerged as soap bubbles and made a series of price boom and therefore the new improved markets are closely monitored  For the U.S economy's housing market is also a very sensitive market to predict future price increases Most mutations may also suggest U.S interest rates in the future, and there is also a major factor affecting the value of the GBP/USD Besides interest rate, unemployment rate, and reporting the number of retail outlets (retail sales) are important, too 4.2.6.1 Technical analysis Technical analysis is the framework in which traders study price movement The theory is that a person can look at historical price movements and determine the current trading conditions and potential price movement The main evidence for using technical analysis is that, theoretically, all current market information is reflected in price If price reflects all the information that is out there, then price action is all one EST stands for Eastern Standard Time (= GMT - 5) ề Đ án Ki nh tế would really need to make a trade Basically, if a price level held as a key support or ố qu Technical analysts look for similar patterns that have formed in the past, and will form trade ideas believing that price will act the same way that it did before Technical analysts use charts because they are the easiest way to visualize historical data You can look at past data to help you spot trends and patterns which could help you find some great trading opportunities As more and more traders look for certain price levels and chart patterns, the more likely that these patterns will manifest themselves in the markets 4.2.6.3 Sentiment analysis Each trader has his own opinion or explanation of why the market is acting the way they Indeed, the market basically represents what all traders feel about the market Each trader's thoughts and opinions, which are expressed through whatever position they take, help form the overall sentiment of the market tế trades around that historical price level c resistance in the past (chart 4.1 below), traders will keep an eye out for it and base their ề Đ án Ki nh tế The problem is that as traders, no matter how strongly you feel about a certain ố qu can about it As a dealer, you have to take all this into consideration It's up to you to gauge how the market is feeling, whether it is bullish or bearish Ultimately, it's also up to you to find out how you want to incorporate market sentiment into your trading strategy Being able to gauge market sentiment can be an important tool in dealer’s toolbox To recap, technical analysis is the study of price movement on the charts while fundamental analysis takes a look at how the country's economy is doing And market sentiment analysis determines whether the market is bullish or bearish on the current or future fundamental outlook Fundamental factors shape sentiment, while technical analysis helps us visualize that sentiment and apply a framework for our trades Those three work hand-in-hand to help dealers come up with good trade ideas 4.3 Recommendation to SBV During 2011, we observed a lot of intricate fluctuation in global financial market that impacted extensively on FX market According to detailed analysis and timely evaluation, SBV actively gave out several solutions and policies to manage tế dollar is going to go up, but everyone else is bearish on it, there's nothing much you c trade, you can't move the markets in your favor Even if you truly believe that the ề Đ án Ki nh tế exchange rate and FX reserve in order to stabilize the market Especially, at the end of ố qu Last year, SBV adjusted interbank exchange rate up to 9.3% Governor Mr Binh felt sufficient confidence in his policy to publicly pledge that any VND loss in value would be limited to 1% in Q4 of 2011 And his confidence later turned out to be justified After some gyrations, the USD/VND rate returned to stability around VND20.820 on both interbank and unofficial markets This long-lasting period of stability on the FX front has clearly helped the SBV to replenish the level of foreign exchange reserves, approximately 16 billion USD or 1.9 month imports (chart 4.2) In short, SBV has executed several synchronous solutions to move from mobilizing-lending foreign currencies to buy-sell ones, gradually limit dollarization and stabilize Dong valuation Recently, SBV has been issued Circular No 07/2012 takes effect on May, 2012 that regulated about foreign credit and exchange position of credit institutions In detail, the circular forces commercial banks have to reduce the opened exchange position, and limit foreign lending to customers In current situation, SBV wants to minimize exchange risk and foreign speculation, and to centralize its control power In fact, with stable exchange rate from the end of 2011 until now, it has supported a lot for FX trading at commercial banks, somehow reduced exchange risk in interbank market Nevertheless, all policies are just used in short term and have a lag time to see a clear effect In order to enhance the exchange risk management and the Vinaforex development, I would like to recommend some ways out to SBV  Building exchange rate followed supply and demand needs Taking the role as Central Bank, SBV manages currency market by intervening buying and selling activities, announcing interbank rate, capping spot exchange rate, regulating percentage change in forward exchange rate Indeed, those policies tế deficit, the dollarization was significant, and carry trade has developed c 2011, Vinaforex market had been in strained situation due to high inflation, high trade ề Đ án Ki nh tế somehow restrain the development of FX market However, we cannot float totally the ố qu In recent time, exchange rate is extended its amplitude in a range of 2% - 3% in 2012 (guaranteed by Governor Nguyen Van Binh) After raising the magnitude, if:  The market does not use maximum the upper band, it means the supply and demand reflect the need of the market properly Then, SBV can consider opening more about the bandwidth  The market uses maximum the upper band constantly, it means exchange rate is lower than equilibrium rate So, SBV can adjust exchange rate in reasonable way to avoid shock in the market  In long term, the bandwidth should be removed SBV should interfere in FX market in the way to benefit for the economy, but not directly fix exchange rate Additionally, it should use to interest tools to manage FX market  Expanding and improving foreign interbank market Foreign interbank market is a trading place amongst credit institutions Interbank market is supervised and operated by SBV, so it reduces the negative impact on FX market For developed economy, this market runs quiet effective, occupied 85% of total FX trading Some suggestions as followed to have more efficient interbank market:  SBV will play its role as the last trading player in FX market Besides, SBV also joins in the market and carries out all FX operations as forward contracts, swap contracts to support commercial banks and help them actively trade in the market  At the moment, since only 60 institutions had joined in interbank market, and almost are one way transaction (means that some banks only sell, and some only buy), the liquidity of the market is not quite high, and the demand and supply of tế we need to take step by step gradually c exchange rate due to macro reasons The exchange management is quite sensitive and ề Đ án Ki nh tế foreign currencies is not at equilibrium Thus, we need some crucial banks play as key ố qu c pillars, and big banks have to create environment and help smaller banks join in the tế market  SBV could set up interbank market via two channels: foreign market between all commercial banks, and one via brokerages  SBV could establish Vinaforex associations to exchange and share experiences, and also open training courses, that specializes in FX, to its members  Improving quoted exchange rate methodology Traditionally, exchange rate of VND is only pegged in USD Indeed, US dollar is stable currency, and US has quite low inflation rate Meanwhile, VND valuation is so varied, and it contains high inflation rate Thus, when USD appreciates in compared with other currencies, VND will appreciate, too, and vice versa If USD valuation changes unpredictably with other currencies, Vinaforex operation will have implicit risks insight its system With the aim to limit the dependence of VND in USD, SBV can implement some methods as:  Diversification foreign currencies in international trade Using some strong currencies, account for particular proportion in international payment  SBV could use a basket of foreign currencies (it can include some popular ones as USD, EUR, GBP, JPY, CNY, CAD) to set up exchange rate of VND In specific period of time, some currencies will appreciate, others will depreciate, but the valuation of VND pegged on this basket will not be changed Thus, exchange rate of VND will be very objective regarding to others  Establishing FX brokerage firms As in developed FX market, FX brokerage firm is the linkage between supply and demand of customers, and those firms are quite developed In charge of intermediary, brokerage firms conduct the foreign transactions easier between commercial banks that want to buy and sell by matching quoted rate of each bank In ề Đ án Ki nh tế principle, brokers only trade for their clients, not for their own account, they will ố qu c charge some service fees and take commission from both banks tế Trading via brokers will be more benefits than directly amongst commercial banks due to several reasons as below:  If a bank want to long or short foreign currencies will be spread out widely and speedy  The name of the bank is kept confidentially  Exchange rate matching by brokers is the best rate (called inside rate, to see the mechanism refer to appendix 5)  Could be applied for both spot and forward transactions Even Vinaforex does not have brokerage firms recently; SBV can step by step run this plan in long term Also, SBV can allow some strong banks (like Agribank, BIDV) establish subsidiary company to specialize in this field In summary, basically, Vinaforex is only operated in the boundary of a country The participation of commercial banks in international FX market is limited Hence, Vinaforex needs to be developed progressively to contribute an essential part in national integration ề Đ án Ki nh tế ố qu c tế CHAPTER V: CONCLUSION Our country, Vietnam, has been entered to integration century with the exciting development of finance and banking sector Considered as potential incomes underlying banking operation, FX trading operation is more and more attractive and advanced In fact, this activity contributes to a large proportion into total revenues of the bank However, FX trading contains a lot of risks, especially; exchange risk might be caused the big loss for the bank even with small change in pips Additionally, recently we have faced with a lot of difficulties in the world such as sovereign debts in Euro zone, recession in US, and our macroeconomics is still in tough circumstance, specifically, high inflation rate, slowly growth in GDP, trade deficit, the stock market kept decreasing in 2011 All together will caused the unpredictable fluctuation of exchange rate, and it is so difficult to control exchange risk Hence, commercial banks in general and Agribank in particular have to implement detailed solutions in order to enhance the effectiveness in FX trading Based on the theoretical framework about exchange risk management, the study of current situation in Agribank, and the development trend of FX trading at Agribank in the future, I gave out some ways out for Agribank in my thesis Significantly, setting up position limits and forecasting exchange rate movement will be the most important tasks, personally Hopefully, these ideas will be the references that Agribank can consider to perfect its exchange risk management system Besides, in terms of macro view, SBV should have a long term plan to improve and advance Vinaforex market to be more and more modern and effective Even we ề Đ án Ki nh tế have a lot of work to do, I believe that developing FX market will be the first step to ố qu c help us integrate well in WTO tế Last but not least, I look forward to receiving any comments to complement and fulfill my thesis And I also express my honor to all staffs and managers at Agribank, especially professor Dang Ngoc Duc, who help me a lot to complete this paper APPENDIX 1: Overlap-trading sessions Time zone New York GMT Vietnam Tokyo open 7:00 pm 0:00 am 7:00 am Tokyo close 4:00 am 9:00 am 4:00 pm London open 3:00 am 8:00 am 3:00 pm London close 12:00 pm 5:00 pm 12:00 am New York open 8:00 am 1:00 pm 8:00 pm New York close 5:00 pm 10:00 pm 5:00 am APPENDIX 2: Other major pairs Euro crosses ề Đ án Ki nh tế Yen crosses ố qu c tế Pound crosses Other crosses Exotic pairs ề Đ án Ki nh tế ố qu c tế APPENDIX 3: Charter capital growth of some Vietnamese commercial banks Updated in 2011 Unit: billion VND ề Đ án Ki nh tế ố qu c tế APPENDIX 4: Currency Correlation Table Updated in Apr, 2012 Note: Weak (Green): the absolute value of the correlation coefficient 0.3 Medium (Yellow): the absolute value of the coefficient is in the rage [0.3, 0.5] Strong (Orange): the absolute value of the coefficient is [0.5, 0.8] High (Red): the absolute value of the correlation coefficient 0.8 The correlation coefficients are calculated using the daily closing prices seen over the last 40 trading days (shorter-term) These two periods have been chosen from among two hundred possible correlation periods based on how well their correlation coefficients correspond with the daily price fluctuations ề Đ án Ki nh tế ốc qu tế ề Đ án P a g e | 86 Ki nh tế APPENDIX 5: Inside rate of brokers ố qu c Principles in trading via brokers: tế A bank can set up bid rate and offer rate or both Bid rates are always smaller or equal to offer rate When bid rate is equal to offer rate, brokers will matching orders and take commissions Inside rate of broker is the best because of: - Bid rate is the highest rate - Offer rate is the lowest rate Inside rate: USD/SGD Banks want to buy Bid rate Offer rate Banks want to sell A 1.6409 1.6419 a B 1.6410 1.6418 b C 1.6411 1.6417 c D 1.6412 1.6416 d E F 1.6413 1.6415 1.6414 1.6414 Order matching Order matching Inside rate 1.6413 e f 1.6415 SGD: Singapore Dollar REFERENCES Supervisor: Dang Ngoc Duc, PhD Finance 50 Quan Thi Hanh Mai – Class: Advanced ề Đ án P a g e | 87 Ki nh tế Ed Ponsi, 2007, Forex patterns and probabilities – Trading strategies for trending ố qu Agribank intramural reports of FX transactions in 2010 and 2011 The State Bank of Vietnam www.sbv.org.vn General Statistic Office website www.gso.gov.vn Agribank website http://agribank.com.vn FX school http://babypips.com Supervisor: Dang Ngoc Duc, PhD Finance 50 Quan Thi Hanh Mai – Class: Advanced tế Nguyen Van Tien, 2011, Forex market and derivatives, GSO Publisher, Vietnam c & range-bound markets, John Wiley & Sons, USA