Forex Investment and Currency Trading

Singapore’s economy remains highly dependent on global trade – and thus highly vulnerable to a downturn in external demand. Indeed, exports as a percentage of overall GDP are around 185%. With the global economy slowing sharply, the Monetary Authority of Singapore (MAS) eased monetary policy on 10 October, moving to a neutral FX policy stance from a tight stance. Over the last weeks the Singapore dollar (SGD) Nominal Effective Exchange Rate (NEER) has moved back to the strong end of the policy band. Over the coming months it’s expected the SGD NEER to move towards the floor of the policy band due to recession risk and as inflation has been defeated. It’s calling for a correction higher in USD-SGD for much of this year and continue to anticipate USD-SGD gains well into 2009. USD-SGD forecasts, where expect the peak of 1.56 in mid-09, are well above the current forward rate.

Look at transaction risk here mainly from the perspective of a Singaporean exporter given the huge external trade and current account surpluses. The good news for Singaporean exporters to the US is that they have the luxury of reducing their hedge ratios due to the rise in USD-SGD. The bad news is that their export volumes are being hit hard by the fall in external demand. Forecasts anticipate much higher USD-SGD levels than is currently anticipated by the forwards. The first priority of Singaporean exporters is to reduce and maintain low hedge ratios on USD-SGD. The second priority is to consider hedging structures that are appropriate to the time, the exposure and current market conditions:

USD-SGD 3M Covered Write:

• Sell USD-SGD 3M forward outright
• Sell 3M 1.60 USD call / SGD put
• Spot reference: 1.4705
• Premium received: USD 0.17%

Singaporean exporters may need to translate back to SGD irrespective of market pricing for cash flow purposes. This leaves them three choices: wait until receipt and translate, sell forward outright now or use an option to manage the risk and reduce the cost. In this case, choose a simple covered write, whereby the exporter sells 3-month forward outright – or whatever tenor as appropriate – and sell a USD call / SGD put against it. The premium gained effectively improves the forward entry rate. This structure may be particularly attractive given the massive spike in USD-SGD implied vols. Moreover, it’s expected the up-trend in USD-SGD to be relatively gradual. It may well retest the 1.55-1.60 area, but most likely not until Q2-09. It’s chosen a 1.60 strike, but obviously the strikes can be adjusted depending on the company’s risk/reward profile.

USD-SGD 3M Call Spread:

• Sell a 1.53 USD call/SGD put, Buy a 1.60 USD call / SGD put
• Spot reference: 1.4705
• Premium received: USD 0.72%

Alternatively, exporters can take advantage of the shape of the vol and forward curves to consider selling a call spread. As ever, the strikes can be adjusted to suit the risk/reward profile. In addition, this can be done on a 1×1 basis or a 1×2 basis, if the company is confident that USD-SGD will not hit 1.60 over the next three months, in order to improve net premium received.