Risky Chinese Derivatives
The yuan-dollar exchange rate is approaching a dangerous level that can put local companies, which purchased derivatives for exchange hedges, in trouble.
According to the Chinese Foreign Exchange Trade Center (CFET), the Shanghai exchange market hit the lowest yuan-dollar exchange rate at 6.1954 as of 10:22 am on March 19.
On March 18 and 19, the rate was dangerously closing to the 6.2 range, causing a fear of massive loss in derivative product investment.
Since last February, analyses have been put forth saying that the measure to lower the yuan rate was to fend off the inflow of foreign money aimed at benefiting from a strong yuan.
It is estimated that Chinese individuals and companies contracted up to US$150 billion worth of Target Redemption Forwards (TRF), which would turn lucrative in case of a high yuan. Many companies exporting to China purchased derivatives to hedge against risks involving a stronger yuan.
TRF already caused the loss of US$2.3 billion, according to Geoff Kendric, the head of Morgan Stanley’s Asia Currency & Exchange Department.
Morgan Stanley expects every 0.1 yuan increase in the exchange rate will result in US$4.8 billion potential losses once the exchange rate goes beyond the 6.15-6.20 yuan range.