Browsing by Author "Soopal, D. C."

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An evaluation of the use of currency options as an alternative hedging strategy to forward exchange contracts for the management of foreign exchange risk in a multinational firm.
(2006) Soopal, D. C.; Strydom, Barry Stephen.
Currency exposure has become a widespread issue as more corporations of all sizes source and sell in overseas markets and compete both at home and abroad with international companies. Very few companies are unaffected by currency risk, whether directly or indirectly. Businesses that source products from foreign countries face the risk that exchange rate movement will erode gross margins if competition prevents selling prices from rising in tandem, while resource-based companies face the uncertainty associated with the fact that the world's commodities markets are denominated in US Dollars or Pounds Sterling while their costs are often denominated in their local currencies. Businesses that ignore exchange rate volatility expose themselves to unnecessary risk, which could have significant consequences if exchange rates suddenly move unfavourably. The volatility of the South African Rand over the past few years is forcing treasurers and other managers responsible for international trade to look anew at how South African exchange rate fluctuations affect their company's results. Many companies have suffered from the effects of fluctuating exchange rates; some have reported losses running into millions of Rand. While more and more firms realize that they should manage foreign exchange risk, not all of them have come up with an appropriate management strategy. There has always been a great deal of debate over the best approach to hedging, or the best methods to forecast exchange rates; however hedging is of the utmost importance for companies. With the recent volatility of the rand, the multinational firm covered in this thesis, showed foreign exchange losses amounting to several millions, using forward exchange contracts to cover its high foreign exchange exposures. The major disadvantage of the forward contract as experienced by the firm and shown in this thesis is that it is a legally binding agreement and thus the firm was bound to accept the agreed exchange rate and also the fact that the exchange itself had to be done. If the commercial reason for the exchange disappeared, the cost of cancelling the forward contract would be quite high. In addition, if the exchange rate at maturity was more favourable to the firm than the one agreed to in the forward contract, the firm will still have to honour the contract and will not be able to take advantage of the favourable exchange rate. Thus, with FEC there is the elimination of the opportunity for profit, should exchange rates turn out favourably. When purchasing a currency option, however, the holder is protected from downward movements in the exchange rate whist still having the opportunity to benefit if the currency moves favourably. Hence, the purpose of this thesis was to evaluate the use of currency options as an alternative hedging strategy to forward exchange contracts to manage the firm's foreign exchange risk. It was found that, had the firm used currency options as compared to FEC over the last four years, the firm would have made significant saving in spite of the option premium. The firm would have enjoyed the flexibility offered by currency options, that is, to let the contract lapse when it would not be to the firm's advantage thus making a lower payment for its imports than would be paid under the forward exchange contract for the same period. The results were tested over a period of four years to prove that the difference in payments using the FEC and the currency options were statistically significant. What was apparent from the research, however, was that though the multinational firm could choose from a vast array of financial instruments and currency derivatives to manage its foreign exchange risk, the firm chose to stick to using forward exchange contracts. The reasons varied from fear of dealing with the complexities of the many instruments available on the market to the limited resources within the foreign exchange department to understand the technicalities of the various instruments. The investigation revealed though forward cover as used by the firm was more efficient in terms of ease of use. Currency options when applied to cover the firm's foreign imports resulted in less cash outflow, making it better and more profitable than forward exchange contracts. Options contract, though more expensive, would have allowed the firms to let the option lapse and therefore benefit from spot exchange rates if these were more favourable.
An investigation of inflationary expectations, money growth, and the vanishing liquidity effect of money on the interest rate in South Africa : analysis and policy implication.
(2001) Soopal, D. C.; Simson, Richard Andrew.
This thesis measures the extent to which the interest rate falls after an increase in the money supply. Even though the South African Reserve Bank has as a commitment, a goal for the inflation rate to vary between a prescribed band, it still needs to be able to use active monetary policy if economic conditions require intervention. To this end it is of interest to measure the number of quarters for which interest rates remain low after the liquidity of the macro-economy improves. In the monetary literature (for example Melvin (1983)) there are methods that have been used to measure the duration of the decline in the interest rate. These models have not to our knowledge been tested using South African data. We find evidence that the monetary authorities can induce falling interest rates for approximately one quarter using appropriate monetary policy. This result was subjected to testing under alternative assumptions concerning the structure of the error term and found to be robust. This thesis argues for the first time, that there may not be a set pattern to the time path of the interest rate, and inflationary expectations may cause the interest rate to rise, however, this rise is not confined to one uniform adjustment over time, but may occur in separate discrete adjustments. This theoretical innovation and the possibility of an identification problem suggested we estimate another more general model of interest rate determination The second model we estimate is that of Mehra (1985). After a careful analysis of the data to ensure that there are no major statistical problems with the South African data, we find that inflationary expectations result in a higher interest rate especially in times of higher expected inflation. Thus, one benefit of the Reserve Bank's current policy that aims for a band between which the rate of inflation (appropriately defined) must fall, is an improved operation of the transmission mechanism. Therefore, if intervention is required, say, if the economy suffers a severe supply shock, then monetary policy can be effective.