Simulated trading platform (Interactive Broker)
Use a simulated trading platform (Interactive Broker) to answer some question with the trading. The username is: sfsud4662 The password is: tecsf686 for Interactive Brokers.
In this project, you can take one of two routes. The first route is the speculative, more trading-oriented option. The second route is more corporate-financed based, in which you hedge out some of your corporations exchange rate exposure. You (or you and your group, should you wish to work in groups of up to 4) may choose either route you like.
Either way, you’ll first need to access IB’s platform by running something called the ‘Trader Workstation’, or TWS. You can download it here:
Once downloaded, open it up and enter in the login information that was emailed to you. Make sure you select ‘Paper Trading’:
If you’re in a group, you’ll really only need one account. What’s important is the screenshots and documentation that you show me in your report.
What to turn in:
On the first page, put please all of your names as well as what option you chose. Only one person per group needs to submit to the submission box on iLearn. The due date is midnight, three full days after our final.
Your report should be single spaced, 9 point font, Times New Roman. Beyond that, the specific instructions of what to include in your report will depend on which of the two choices you select.
So, if you’re interested in the speculative, trading-oriented option, go to page 2. If you’re interested in the corporate finance hedge approach, go to page 7.
Option 1: Speculative Trading
In this class, you’ve learned a lot about what moves currencies. Particularly from Chapter 9 (exchange rate determination), but also from other chapters. Now’s your chance to start putting money to work on the basis of what you’ve learned.
Review the approaches you’ll use to pick currencies to long and short. These approaches should be based on what you learned from the textbook, so I’ll expect that your group justify each approach using citations from the textbook. For instance, if you’re going to use PPP as one approach, explain in your report how PPP can be used to forecast currency movements.
Debate amongst your group, and choose at least three approaches that you’re going to deploy in constructing this portfolio. A discussion of the three approaches and why/how you’re using them should be the first part of the report.
Pick at a minimum 6 currencies pairs to bet on (e.g., EUR/USD, USD/JPY, USD/BRL, and so on). Half of these should be a currency in which you particularly want to go long, and the other half ones you particularly want to short.
List these currency-pairs in your report, and for each, discuss why you are going long (‘bullish’) or short (‘bearish’), respectively. (You’ll want to justify your long or short positions by applying your principles for determining exchange rate changes from Step 1).
If you need some inspiration, my suggestion is to visit here:
Find these currencies on InteractiveBrokers. The ‘tickers’ for these currencies in the spot market can be found here:
However, if you’ll remember one of our previous in-class exercises, you can also find futures, options, CFD’s, and even ‘Options on Futures’ for many of these currencies. I suggest you browse these tabs and try to find ways to trade your currencies in addition to just using the spot market.
Figure 1. List of products that you can trade via TWS. Note that Options, Futures, and Futures Options (FOPs) can also be found here for your currencies.
List the contracts that you intend to buy/sell, and discuss why. Can you relate this to trade ideas? For example, if you’re long the USD because of an expected interest rate hike in the summer and you want to take on this position with a futures contract, you’ll need to be long a futures contract for the USD with at least that long of a maturity.
The next step is to actually trade these currencies. Here is where you’ll need to log on to TWS and enter some orders.
Typically, you’ll be able to find the currency and type of contract (future, option, spot, etc) you want to trade by simply typing in the ISO code into the top left of the order entry screen and pressing enter. TWS will then give you a list of different contracts that are available and you can select from them.
For example, I typed in ‘GBP’, the ISO code for the Great British Pound in the screenshot below. A list of spot, futures, and other contracts then pop up for me to select, and I can select the maturity that I want to trade:
The GBP is heavily traded. Let’s say I want to buy a futures option—which is like an option written on a futures contract. Perhaps I think that, given it’s April at the time of writing this, and I think that Britain is going to release higher than expected inflation numbers at the beginning of next month, I want to take a short position on the GBP with a May expiry date:
In this case, betting on a fall in the value of the Pound means that I’d want to buy a put on the pound. Given that right now the spot rate between the USD and GBP is 1.40 USD per 1.00 GBP (or GBP.USD=1.4088), perhaps I’ll buy a put that’s slightly out-of-the-money, at a strike price of $1.38 USD per GBP.
(Remember, this is out of the money because right now the pound buys more, 1.40 dollars. If the pound weakens, it’ll buy fewer dollars. If it weakens beyond 1.38, to 1.35, say, my put will still enable me to sell at the higher price of 1.38. I’ll then earn the difference between what the spot is and my strike—in this case it would be three cents per pound).
I click ‘OK’, and then I go back and click ‘BUY’. Here, I’ll just test an order of one contract so you can see what it looks like:
Since the markets are closed at the time of writing, IB won’t give me a price. But I can see on the right hand side the approximate benefit of this position. If the pound falls by 10%, this contract will make me $6,780. On the other hand, if the pound rises by 10%, this option will make me exactly zero dollars (it’s a put option).
This is a more complicated example, but hopefully it shows you a bit of the ordering process. Trading spot or futures directly will be a bit more easy, but the same process still applies.
The final step is to describe the trades you placed. How much did you buy/sell of each, and why? Please describe this in your report, as well as include pictures of your final portfolio on IB.
(Click the ‘Portfolio’ tab to see what you own—here, it shows that I own 1 million USD cash, and have no other positions):
Option 2: Hedging Corporate Cash Flows
Let’s say you’re a medium-sized U.S.-based manufacturer of graphene-based industrial products. You’ve decided to open up a manufacturing subsidiary based in Germany as part of your expansion into the E.U. You’ve chosen Germany because of both a skilled, technical labor force as well as favorable tax treatment (income earned outside of Germany by subsidiaries that are based in Germany are not subject to German tax).
It’ll take two years to get the factory in Germany up and running and making its expected revenue. Until then, you have to pay for construction costs as well hire your workforce.
As the CFO of this U.S. company, you know it’ll take you 2 million Euros to get started. Broadly speaking, your job is to lock in the amount of dollars it’s going to cost you to create this European base.
Specifically, here’s the transfers that you as a CFO are going to face:
1) An initial transfer of €400,000 right away, to cover the down-payment on construction costs in Dresden (the city outskirts, where you’re planning to build).
2) A follow-on payment of €600,000 is required in six-months, both to cover ongoing-construction as well as to begin to cover salaries of newly hired managerial staff.
3) The remaining €1,000,000 is due in one year—this will cover factory completion as well as salaries of the manufacturing workers.
Step (1) will involve a direct transfer in the spot market. But it’ll be up to you to decide how to hedge the currency risks that you face today as a result of steps (2) and (3).
Discuss as a group the strategies that you can take to lock in the amount of dollars you’ll have to pay today in order to go through with steps (2) and (3) above. Outline the merits and disadvantages of each, and then choose which approaches to hedging you’re going to do.
Once you’ve done that, use one of your InteractiveBrokers accounts to actually make both (1) the spot transaction of dollars to Euros and (2)-(3), the hedges of your €0.6M and €1.0M exposures in six and twelve months, respectively.
In a report of 3-5 pages, please present the following:
• A summary of the problem that you, the CFO face.
• The outline of the cash transfers that need to take place.
• The strategies that your group discussed, and the merits and disadvantages of each.
• The strategies toward hedging exposures in steps (2) and (3) that you ultimately decided to go through with, and why you chose these strategies in particular.
• A ‘journal’ or narrative of your experience in using one of your accounts (you each have 1M USD in the account, it’s OK to use someone else’s account if you make a mistake in trading).
• Your takeaways, as a group, of what you’ve learned after implementing the hedges. (I’m interested what you’ve learned here in applying the concepts of this course, not whether you got the hedge exactly right. Just tell me all that you learned as a result of this assignment—I’m not grading here based on whether or not you made a mistake).
In addition to the above, please append the following to your text. This should be about 3-5 pages in length, although as these are pictures, the page length is flexible:
• Screenshots of each of the trades that you made, using the InteractiveBrokers platform.
o To take a screen capture on a PC, press Ctrl+Print Screen
o To take one on a Mac, press Shift-Comand-4 (it’ll show up on your desktop)
• These should show the trades after you’ve executed them. Since these are hedge trades, above or below each picture, please write/type the EUR.USD spot exchange rate at the time you executed each trade.
For practical tips in doing the trades, I’d suggest taking a look at the walkthrough on Option 1. In addition, there’s a ton of videos and docs on IB itself (https://www.interactivebrokers.com/en/index.php?f=14509). It’s also OK to just try things out on your own IB account; actually, directly experimenting is probably the best way to learn.
That’s it! Report is due (via iLearn submission) three full days after our final.