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© FIRST NATIONAL BANK Global Payment and FX Market Update Presented by: Michael Salerno and Jon Macapinlac
© FIRST NATIONAL BANK Overview Payment Types Clearing Systems Foreign Exchange Market and Rates Foreign Exchange Risks Risk Management Tools Update on the Currency Market
© FIRST NATIONAL BANK Foreign Cash Letter Items Checks drawn off a Non-US Bank These items can not be cleared by the Federal Reserve Takes longer to receive collected funds Additional Fees to process these items Can not be imaged, and must present physical item to the bank
© FIRST NATIONAL BANK Check Collections Checks not drawn off a US Bank Beneficiary does not receive funds until the bank has received collected funds Credit could take 2 to 4 weeks Used for higher value or riskier transactions Lager fees associated with this service
© FIRST NATIONAL BANK Drafts Drafts - Issues a check drawn off the country of the beneficiary Can be issued in USD, local currency, etc. Clearing process is manual in most countries Most vendors will not process order until collected funds due to risk of transaction.
© FIRST NATIONAL BANK High vs. Low Low value payments – bulk payments (low value, high volume) settled through clearing house. -Example: ACH High Value Payments - payments cleared and settled in near real-time - Example: Wire or Fed Wire
© FIRST NATIONAL BANK Fedwire – US funds transfer system operated by the Federal Reserve Bank that enables its participants clear funds electronically – Over 9289 participants –Average daily value: 2.7 trillion – Average daily volume: 537, 000 payments Wire Transfers
© FIRST NATIONAL BANK Fedwire Sending institution Receiving institution Sending customer Receiving customer FED
© FIRST NATIONAL BANK Wire Transfers CHIPS – Clearing House Interbank Payment System –Used to clear USD International Wires –Owned by Financial Institutions –47 participants –Netting engine (not real-time) –Over 1 trillion cleared daily –More than 250,000 Interbank payments cleared daily
© FIRST NATIONAL BANK CHIPS Transfer Sending institution Receiving institution Sending customer Receiving customer CHIPS Correspon dent Receiving institution Sending Correspondent Receiving Correspondent
© FIRST NATIONAL BANK Wire Transfers SWIFT - Society for Worldwide Interbank Financial Telecommunication Member owned cooperative – More than 8,300 members in 208 countries – Standards body –Only provides messaging or communication not settlement
© FIRST NATIONAL BANK CHIPS Transfer Sending institution Receiving institution Sending customer Receiving customer Correspon dent Receiving institution Sending Correspondent Receiving Correspondent
© FIRST NATIONAL BANK SWIFT Transfer SWIFT only is the communication between banks Settlement is dictated by the SWIFT Message (MT103) Settlement can occur by book transfer, local wire, local clearing network, etc.
© FIRST NATIONAL BANK What is SWIFT? A community inspired co-operative founded by and for the financial industry Provides the platform, products and services that allow our customers to connect and exchange financial information securely and reliably Act as a catalyst that brings the financial community together to work collaboratively to shape market practice, define standards and consider solutions to issues of mutual concern and interest
© FIRST NATIONAL BANK SWIFT in figures 2.5 billion messages per year 8,612 customers 209 countries and territories Over 2,000 employees Average daily traffic 15.1 million messages Peak day of 17.1 million messages – 30 September 2008 Source: Swift.com
© FIRST NATIONAL BANK 16 SWIFT – A customer centric user community Banks IMI's Corporates Insurance Companies Payments MI's Government Institutions Trustees Broker-Dealers Payment Systems Clearing & Settlement Systems Depositories Stock Exchanges Securities MI’s Mid-America Conference - October 29, 2009
© FIRST NATIONAL BANK FIN message categories Category 1 – Customer Payments & Cheques (18 messages) Category 2 – Financial Institution Transfers (17 messages) Category 3 – Treasury Markets – Foreign Exchange, Money Markets & Derivatives (27 messages) Category 4 – Collections & Cash Letters (18 messages) Category 5 – Securities (67 messages) Category 6 – Treasury Markets – Metals & Syndications (20 messages) Category 7 – Documentary Credits & Guarantees (29 messages) Category 8 – Travellers Cheques (18 messages) Category 9 – Cash Management & Customer Status (29 messages)
© FIRST NATIONAL BANK URBK US 33 Your SWIFT BIC Code (*) Online access to the SWIFT BIC directory via Bank Identifier Code (BIC) A SWIFT BIC identifies financial institutions on the SWIFT network
© FIRST NATIONAL BANK Time and Money Originator IBK #2 IBK #1 Originating Bank Beneficiary Bank Beneficiary USD 50, Fedwire USD 50, USD FEE Convert to local Currency EUR 33,692.72Credit account
© FIRST NATIONAL BANK Time and Money Originator Correspondent Originating Bank Beneficiary Bank Beneficiary USD 50, Credit account Convert to local Currency EUR 35, * Bene receives 1, more Euro and in less time
© FIRST NATIONAL BANK The Foreign Exchange Market Global decentralized financial market for trading currencies with the market determining the values of different currencies Huge trading volumes represents the largest asset class in the world leading to high liquidity Over 95% of FX market volume consists of speculative trading. Speculation is the primary cause of market volatility. Volatility causes exchange rates to change every second of the day, 24 hours a day
© FIRST NATIONAL BANK The Foreign Exchange Market Annual Stock Markets' Volume Australia$1,062,000,000,000 Toronto$1,368,000,000,000 India$1,059,000,000,000 Korea$1,607,000,000,000 Germany$1,628,000,000,000 Tokyo$3,787,000,000,000 China$9,564,000,000,000 London$2,741,000,000,000 NASDAQ OMX$13,439,000,000,000 NYSE Euronext$19,813,000,000,000 Total One Year$56,068,000,000,000 (56 Trillion) Source NASDAQ Foreign Exchange Average Totals One Day$3,098,000,000,000 One Month$62,000,000,000,000 FX Total One Year$744,000,000,000,000 (744 Trillion)
© FIRST NATIONAL BANK FX Markets Over the counter – Majority of foreign exchange is traded over the counter between Financial Institutions and their counterparties. - spot, swaps, and forwards Exchange Traded – FX is also traded on exchanges such as CME to help reduce counterparty exposure. –Spot, swaps, and futures
© FIRST NATIONAL BANK FX Markets The two main FX markets are spot and forward market Spot Market – for the delivery of funds with in one to two business days from the trade Most payments and wire transfers are spot transactions
© FIRST NATIONAL BANK Forwards vs. Futures Forwards are completely customizable –Amounts, currency, and value date or date range Futures – Standardized contracts –Set amounts and value dates EUR 100k at 1M
© FIRST NATIONAL BANK Exchange Rates FX rates are quoted in several ways, depending on the currencies and the markets involved CurrencyDirectIndirect Market AUD CAD EUR GBP JPY
© FIRST NATIONAL BANK BID Vs ASK
© FIRST NATIONAL BANK FX Risk What is currency risk? The risk that unexpected changes in exchange rates will: 1) Increase cost 2) Reduce profit margin 3) Create inconsistencies in a company’s balance sheet 4) Create FX gains or losses on company’s income statement
© FIRST NATIONAL BANK FX Risks FX exposure - Companies dealing with foreign currencies face four types of exposure: Transaction exposure Translation exposure Economic exposure Bid-to-award exposure
© FIRST NATIONAL BANK FX Risks-Transaction Exposure Occurs when one currency must be exchanged for another Gain/loss incurred on actual or anticipated currency conversion
© FIRST NATIONAL BANK FX Risk-Translation Exposure Arises from the need to produce consolidated financial statements due to foreign subsidiaries Reflects changes in the book value of foreign subsidiaries No actual conversion of currency involved
© FIRST NATIONAL BANK FX Risk-Economic Exposure Effects of foreign exchange movements on total corporate value Can be long term in nature, difficult to hedge and a serious business influence/consideration
© FIRST NATIONAL BANK Forward Market Forward FX Market – Provides an exchange rate for a future delivery of currencies to be fixed today Forwards are available in most currencies with standard maturities in one, two, three, six, nine, and 12 months The relationship between the spot and forward market is based upon the interest rate parity
© FIRST NATIONAL BANK Forward contracts can be used to “lock-in” financial certainty related to future benefits and/or obligations denominated in a foreign currency. Forward points may be at a discount or at a premium. Based on the “direction” of the hedge, forward points may be earned or paid. Forward Market
© FIRST NATIONAL BANK Forward Market Fixed Date – Contracts with an exact value date Window – Contracts with a date range for value date. –Typical windows do not exceed 30 day, but can be as long as 90 days –Allows flexibility on settlement for uncertain delivery of payment
© FIRST NATIONAL BANK Forward Market Important! The forward rate is NOT intended as an estimate or a proxy of the future spot rate. Hindsight is always 20/20! –The then current spot rate on the forward settlement date is irrelevant to the financial decision. –Forward contracts are intended to bring financial certainty to the transaction, NOT to “out guess” the market. –Forwards enable accurate cash flow budgeting and preparation.
© FIRST NATIONAL BANK Forward Market
© FIRST NATIONAL BANK Non-deliverable Forwards NDF - are forwards contracts that are net settled on value date. Settlement is the difference between the contract exchange rate, and the spot rate on the value date. Are used in markets where there is not an active forward market.
© FIRST NATIONAL BANK Currency Options Options – gives the buyer the right to buy (call option) or sell (put option) a fixed amount of a foreign currency at a fixed exchange rate (strike price), on or before a specific future date Plain Vanilla Put/Call: Buyer must pay a premium for the option. Like an insurance policy, you pay an out of pocket cost for protection against some worse case scenario. Structured Option: Range Forwards (Collars), Participating Forwards
© FIRST NATIONAL BANK Comparison of Hedging Alternatives Unhedged Fully Hedged Do Nothing Plain Vanilla No-Cost Collar (Range Forward) 75% Participating Forward 50% Participating Forward 25% Participating Forward Forward Contracts Risk Potential Upside
© FIRST NATIONAL BANK Why deal in Foreign Exchange? More competitive in global markets When pricing in local currency, more appealing to buyers (they can avoid currency conversions and associated risks) When buying, negotiating in foreign currency can help obtain better price (suppliers may be charging as much as 3% to 12% above normal, hedging against exchange risk) Increased Control/Improved Fee Structure –USD transfers are often converted by a third party institution resulting in increased rates or fees, and delays in delivery.
© FIRST NATIONAL BANK Currency Update Euro Canadian Dollar Chinese yuan
© FIRST NATIONAL BANK Euro Debt Crisis Structural Issues Will the Euro Survive? Quarterly Forecast
© FIRST NATIONAL BANK Canadian Dollar Current economic strength Commodity based economy and heavily reliant on U.S. growth Quarterly Forecasts
© FIRST NATIONAL BANK Chinese Yuan Chinese growth Trading band for CNY Future Prospects Quarterly Forecasts
© FIRST NATIONAL BANK Questions Michael Salerno Director, Foreign Exchange First National Bank Jon Macapinlac Business Development, Foreign Exchange First National Bank
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