Handbook on History of European Banks †MyAssignmenthelp.com

Question: Discuss about the Handbook on History of European Banks. Answer: Introduction: The Swiss National Bank is Switzerland`s central bank that is accountable for any monetary policy in that country and issues Swiss currency bank notes (Munn, 1995).In 2015,the Swiss National Bank decided to withdraw its hedging strategy. A hedging strategy is a type of investment that would help protect finances from risky situations that would bring about losses to the invested currency (Amadeo, 2017).The strategies help derives value from the invested stock which happens to be the real asset. The Euro had formed a downward curve since its main central bank was struggling to deal with the wavering economies. At the same time, the Swiss franc looked more appealing for investment since more people were looking for a safer place to channel their funds during the economic turmoil. So the bank decided to de-peg the franc. There was a belief that the Swiss franc is overseen by a more practical, stable regime and a dominant bank that did not have any debt troubles that were being experienced all over the Eurozone. The weakening of euro and strengthening of Swiss franc caused the bank to make a choice to de-peg as a way to manage risks through hedging strategies. To make the Swiss economy cheaper for its consumers. This would mean that the value of the Swiss currency increases within its boundaries. When the currency had been pegged, the exchange rates were too high. It needed to regain its former glory in the international markets. We see that after the Swiss franc was pegged to the Euro, the Swiss franc became greatly overvalued. Even the bank had to increase its liquidity supply to the Switzerland money market. Overvaluing of currency creates an unfavorable environment for the investors and exporters. The deflationary cycle created. When the Swiss franc became overvalued, this reduced consumer prices as a whole. Consumers realized this, and they started to reduce their purchasing habits waiting for the prices to lower in the near future. When products and goods are not purchased within Switzerland, it is not good for its local industry. These strategies help both the exporters and domestic firms protect their currency against volatility and reduce any losses accrued from currency movement. Below are hedging strategies used by exporters and domestic firms. This type of hedging strategy shifts exchange risk to the other parties. It is characterized by dominance in payables and receivables in the domestic currency. However, if the currency in question is not globally accepted, it can lead to decrease in the bargaining power of the company or reduce the customer base. Sometimes the well-accepted currency globally uses the vehicle currency which does not give the domestic currency or its counterparty`s currency an upper hand. Either way, the choice of favorable currency is based on stability and liquidity as well as transactional costs. (IMF Center, 2015) This involves adjusting the domestic currency to that of foreign currency so as to include any future fluctuations in the markets. This reduces a company`s competitiveness in entire international markets which results in a drop in sales. This is where matching of operations occurs. It includes fitting closely amount and time of receivables as well as payables resulting in minimal net exposure. This could only bring profits to any company if aggressive finance or favorable treasury function and adequate IT systems are present. This is close to matching strategy, but the difference is that it matches subsidiaries and cash flows. Netting requires that any type of transactions is put in a specific and single treasury center for matching to reduce any exposure risk to foreign exchange. This is the bigger picture of netting strategy that involves timing alternation relating to cash flows in order to eliminate transaction exposure through taking advantage of satisfactory exchange rates (Antoci 2015) .Leading is marked by accelerating receivables and payments where expectations, as well as volatility, are considered. Lagging is the vice versa of this. Conclusion Observing what happened to the Swiss National Bank, it is better for any market to assume that instability in FOREX markets will still remain high. The volatility can wipe out any competitive advantage that a certain currency has. So whenever a company invests in a certain market, it is good to have in mind and implement proper exchange rate hedging mechanisms to avoid major calamities resulting from the volatility of currency. Issues of demand change, payment flows and competition in the market need to consider. Putting in place the above hedging strategies would have helped any exporter or domestic firm in Switzerland when the Swiss National Bank decided to either peg or de-peg from the Euro. They would not have been adversely affected by the changes in the economy. (Ulrich) Mostly, this strategy is used in investments in stock index futures as well as a market dominated by local currency. It is entirely vulnerable to money risks.(Konishi Dattatreya, 1996). This is a strategy accustomed to interest level differentials. The Covered Interest Rate Parity principle that supports this strategy states that the forward exchange rates must have the different interest rates for the said countries to have an arbitrage strategy. This is a market strategy where an item can be purchased in a certain market and traded concurrently in another to create returns from price differences amid the two markets. In this case, the U.S interest rate is 5.5%, and that of Euro is 2% (Picardo, 2018) This means that the U.S has a higher interest rate for it to trade with Euro with a lower interest rate due to the forward rate. So ABC`s decision to retain their payment in the Eurozone will not earn them a lot of interest. This is a strategy for putting in place mechanisms against foreign exchange risk. It uses financial market and money market where high liquid, short-term instruments that include banker`s acceptances and treasury bills are traded. This type of hedging strategy is also customized to exact dates and amounts. However, it is complicated since it is usually a step by step method. Placing loans figures and deposits its tiresome. The ABC Company that has exported expects 50 million to be paid. Currently, the spot rate is at $1.10, and yet in a year`s time, it will be $1.13. The annual interest rate in the U.S is higher than that of the Eurozone. For the company not to lose, it should use this strategy as follows; It should borrow the 50 million from Eurozone. Then let the money earn interest from the eurozone. 50,0001.022=51100 then converts using the spot rate; 511001. 10=56210.Then the resulting amount is deposited at an interest rate of 5.5% where the interest earned will be $30915.5 which can be used to pay the loan. The company wont have made any loss. So this is the most favorable strategy. This optional hedging involves speculation and hedging itself as an option also. In speculation, one is not limited to earning profits only when markets are high. Profits can also be made when markets go down or remain constant. Here, money can be made or lost. When a company is choosing a certain option, it has to know the direction of general stock as well as the time it moves and make the right move. There is the risk of being wrong. Hedging among the options is an investment strategy whereby ABC Company can restrict its downside but still enjoy benefits of upside fully in a very cost-effective manner. The money market hedge strategy is the best because the company can borrow a loan, deposit it to earn interest enough to repay the loan and still get its payment for the exported goods. References Amadeo, K. 2017, the balance. Retrieved from;https://www.thebalance.com/kimberly-amadeo-3305455 (Accessed March 22, 2018). Antoci, V., 2015. Managing transaction exposure in MNCs. Retrieved from; https://www.theseus.fi/bitstream/handle/10024/104281/Vitalie%20Antoci%20-%20Transaction%20Exposure.pdf?sequence=1isAllowed=y (accessed March 22, 2018) Ulrich, S. n.d. SWITZERLAND GLOBAL ENTERPRISE retrieved from; https://www.s-ge.com/en/contact/ulrich-hinterberger (accessed March 22, 2018). Munn, C.W., 1995. Handbook on the History of European Banks. Business History, 37(4), pp.121-123. Retrieved from; https://go.galegroup.com/ps/anonymous?id=GALE|A17526686sid=googleScholarv=2.1it=rlinkaccess=fulltextissn=00076791p=AONEsw=wauthCount=1isAnonymousEntry=true (accessed March 22, 2018). https://www.theseus.fi/handle/10024/104281(accessed March 22, 2018) IMF Center. February. 2015, All about money. Retrieved from; https://www.imf.org/external/pubs/ft/ar/2015/eng/wwd-lending.htm (accessed March 22, 2018)