More “derivatives” madness is on the cards. From ET’s “Rising Yen gives companies the jitters“:
As the dollar slipped below Y100 for the first time since 1995, hundreds of corporates and institutions were exposed to a brutal currency market. On Thursday, the dramatic surge in yen (as well as swiss franc) activated several high-risk structures, like ‘knock-in’ options, which were lying dormant for months in corporate treasuries …
…
…The big hits will be in cases where firms have bought knock-in structures. In derivatives, the ‘knock -in’ structure is activated when a currency gains beyond a level. Till that level, the corporate can buy it at an attractive rate.
But once the currency breaches the level agreed in the contract, the corporate has to buy it at the prevailing market rate. If the currency has surged, he has to fork out so much to meet the monthly or weekly outgos as specified in the synthetic contract.
According to a banker, several corporates had done a deal with 1$=Y100 as the knock-in level. For Swiss franc — the other currency that has shown a similar appreciation against the dollar — the knock-in level is 1Sw Fr= $1. On Thursday, the SwFr was trading at 1.0070 — a dangerously close level for the auction to be knocked in. For Euro, the knock-in levels are E1 Euro = 1.59-66, as against the spot price of 1.56.
What many companies may have done is first enter into swap — a transaction that will convert its high-interest rupee borrowing into significantly cheaper yen/Sw Franc loan. Almost simultaneously, they enter into an option contract to protect the risk on such swaps. But these knock-in structures offer only a conditional production.
“Some of the global banks may push up the swiss franc to get the contracts knocked in, and in the process make corporates pay up,” said a banker.Since many contracts will mature between April and August, and several more will get the knock-in contracts triggered in the next few days, some of the local banks are trying to ringfence themselves against difficult clients.
In short, either the corporates or the banks are screwed. No idea about extent of losses, and no idea about who the the corporates or the banks are.
When there is a downturn, all negative news comes out of the woodwork. Things that seemed like a “perfect hedge” unwind themselves in the most unpredictable way. The news may be exaggerated in some cases, like when people say “Sensex will go back to 6,000” and all that. (There is no way of predicting an outlier like that. If you’re wrong no one will remember, and if you’re right everyone will praise you. No risk in making a statement like that, anytime. For the record I predict that the Sensex will either hit 6,000 or 25,000 in the next fifty years. Ha.)
There is likely to be more bad news, or regular news that in these times, becomes bad news. Like they say in Bangalore, yen-jaay.
