Advantages and Disadvantages of Swap Contracts in Vietnam

In the swap contract, the bank and the customer agree on the following main contents:

 Transaction term : The swap transaction term can be from 3 days to 6 months. If the maturity date falls on a Sunday or holiday, the two parties will agree to choose a suitable maturity date and the contract term will be calculated based on the actual number of days.

 Implementation conditions : Swap transactions are applicable to customers who meet the following conditions: (1) have a business license, (2) present documents proving the need to use foreign currency, (3) open a foreign currency account and a VND account at a bank, (4) pay transaction fees as prescribed,

(5) maintain a maximum deposit ratio of no more than 5% of the contract value to ensure contract performance and (6) sign a swap transaction contract with the bank.

 Settlement Date: In a swap transaction, the settlement date includes two different types of dates: the effective date and the maturity date. The effective date is the date on which the settlement of the spot transaction is made while the maturity date is the date on which the settlement of the forward transaction is made.

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 Determining the swap rate : A swap contract involves two types of exchange rates: the spot rate and the forward rate. The spot rate is the rate listed by the bank at the time of the transaction as agreed by both parties. The forward rate is calculated based on the spot rate, the interest rate differential between VND and foreign currency and the actual number of days of the contract.

 Swap transaction implementation process : At Vietnamese commercial banks, the swap transaction implementation process is usually carried out through the following steps:

Step 1 : Customers who want to make a swap transaction should contact the bank's currency trading department.

Step 2 : Based on foreign currency supply and demand, the currency trading department will offer specific prices and terms to customers.

Step 3 : If the customer agrees on the price, both parties will sign the exchange contract.

2.2.2. Advantages and disadvantages of swap contracts in Vietnam

Through two illustrative situations of swap transactions, we clearly see the combined nature of a spot contract and a forward contract at two different times of the swap contract. Thanks to that, it meets the needs of customers to buy and sell or sell and buy back the same foreign currency at two different times.

In a swap transaction, both the bank and the customer have certain benefits. For the customer, the benefit is that the customer satisfies his or her foreign or domestic currency needs at two points in time, that is, on the effective date, and also satisfies the need to buy or sell foreign currency on the maturity date. This is similar to a forward contract, so the customer can hedge against the risk of exchange rate fluctuations.

For banks, the benefits are reflected in the fact that on the one hand, the bank meets the needs of customers, contributing to enhancing its reputation and increasing its brand value. On the other hand, the bank can earn profits from the difference between the buying and selling prices of foreign currencies. On the effective date, the bank can earn profits from the difference between the buying and selling prices of foreign currencies on the spot. On

On the maturity date, the bank makes a profit from the difference between the forward bid and ask prices.

As mentioned, swap transactions are a combination of spot transactions and forward transactions. Swap transactions themselves only solve the drawback of spot contracts in that they can satisfy customers' foreign currency needs at a future time, and at the same time overcome the drawback of forward contracts in that they can satisfy customers' foreign currency needs at the present time. However, like forward transactions, swap transactions still have two limitations:

 It is a binding contract that requires the parties to perform at maturity regardless of the exchange rate on the spot market at that time. This has the advantage of insuring foreign exchange risks for customers, but at the same time, it loses business opportunities if the exchange rate fluctuates contrary to the customer's prediction.

 It only cares about the exchange rate at the effective time and the expiration time without caring about the exchange rate fluctuations during the period between those two times. For example, in the situation of Trung Nguyen Coffee Company above, if at some point after the transaction contract is agreed upon, the USD increases in value compared to VND, the company benefits because it has a positive USD position for a 3-month term. However, at this time the company still does not benefit because the contract has not expired. When the contract expires, that benefit may no longer exist because who knows, by then the USD may have decreased in value compared to VND.

This limitation makes forward contracts and swap contracts only a hedging tool and is more suitable for customers' hedging needs than for business or speculative needs to profit from exchange rate fluctuations.

3. Futures contracts

3.1. Using futures contracts in Vietnamese import-export enterprises

As we know, a futures contract is essentially a standardized forward contract. It overcomes the disadvantage of a forward contract in that it can become a means of speculation in the foreign exchange market. However, here we consider the aspect of using futures contracts to hedge exchange rate risks for businesses. The general principle is that when there is a foreign currency payable and the fear that the foreign currency will appreciate when the payment is due, a futures contract for that foreign currency should be purchased. In this way, two opposite foreign currency positions can be created: a negative position when owing a payable and a positive position when buying a futures contract in the same foreign currency. These two opposite foreign currency positions will automatically neutralize the risk. In the case of a receivable, instead of a payable, we will do the opposite.

With payables :

Although futures contracts are not as easy to negotiate as forward contracts, they can also be used to manage risks in some cases where there are transactions on the futures market. To hedge against risks with a foreign currency payable, a business can buy foreign currency under a futures contract with a value and term equivalent to the payable. Specifically, a petroleum business such as Petrolimex Petroleum Corporation needs a foreign currency of 200,000 USD in 3 months to pay for a gasoline import contract. The business is worried that after 3 months the USD price may increase, causing difficulties for it. At that time,

The company will hedge its risk by purchasing a futures contract worth $200,000 in three months at a predetermined rate. At maturity, there are two possibilities:

 If the USD appreciates against the domestic currency, the business will benefit from the exchange rate fluctuation from the futures contract, but suffer from the increase in the cost of payables. In that case, the business will use the profit from the futures contract to offset the loss of payables. Thus, the loss due to foreign exchange risk is minimized or can be controlled.

 If the USD depreciates against the domestic currency, the business will lose money by buying the futures contract, but gain money from the payable because the exchange rate fluctuation reduces the cost of this money. Then the business will use the profit from the payable to compensate for the loss from the futures contract. In this case, the risk can also be controlled.

Similarly, businesses can also use futures contracts as a tool to hedge exchange rate risk on receivables.

With receivables :

To be able to hedge foreign exchange risks for a receivable in foreign currency, a business can sell foreign currency under a futures contract with a value and term equivalent to the receivable. In the case of a food and foodstuff exporting business such as Cholimex Food Joint Stock Company, the Company has a contract to export frozen shrimp to the EU market with a receivable amount of 120,000 EURO in 6 months. The Company is worried that after 6 months, the exchange rate risk may cause damage to the business. At this time, the Business should seek and have a contract

sell EURO futures with a maturity of 6 months with the same value as the receivable but the exchange rate has been determined. At the maturity date, there are two possibilities:

 If the EURO appreciates against the local currency, the business will benefit from exchange rate fluctuations from receivables but lose from futures contracts. These two things can offset each other, so that risks and losses are controlled.

 Similarly, if the foreign currency depreciates, there are also two opposite flows that occur to eliminate the risk.

Futures trading as presented above is commonly practiced in countries with developed financial markets. Here, futures trading is not only conducted in the foreign exchange market but also in the commodity and stock markets. Thanks to that, the market has an additional tool to hedge against the risk of exchange rate fluctuations. In Vietnam, there are currently a number of banks such as Maritime Bank that have conducted futures trading. However, the transaction is still new and has not really attracted customers.

3.2. Issues to consider when using futures contracts

3.2.1. Futures contract trading mechanism

As we know, investors who want to buy or sell futures contracts will contact a brokerage firm. The brokerage firm will instruct buyers and sellers on the exchange to execute orders to buy or sell futures contracts.

Trading activities are carried out through an intermediary organization called a clearing house according to the following principles:

Money

Clearing Company

Sell futures contracts

Buy futures

Underlying Assets Underlying Assets

Figure 5. Diagram of the mechanism of buying and selling futures contracts

Marking to market daily:

For forward contracts, any interest or profit on the contract is paid at maturity. In contrast, for futures contracts, any interest or profit is calculated daily (added to or deducted from the parties' accounts).

(VND) according to future price fluctuations. This calculation is to partially eliminate the risk for the company to make a compensation payment in case one party to the contract is unable to pay when due.

For example, on February 28, 2010, A signs a futures contract to buy asset X on March 10, 2010 with a future price of Fo = 10,000,000 VND. In reality,

To limit risks, when signing a contract, A must deposit a sum of money in a security account at the payment company. For example, the security level (margin) is 500,000 VND. After each day, if there is profit, the profit will be added to the account, but if there is a loss, the remaining amount will be deducted. If the value of the account falls to a certain limit, called the maintenance margin (for example, VND 200,000), the investor will have to deposit additional money to reach the initial level of VND 500,000, otherwise the securities company will pay all or part of the value of the investor's futures contract to ensure the maintenance margin. be released

3.2.2. Value received by both parties in a futures contract

The buyer in a futures contract must buy the underlying asset at a specified price in the future and will profit if the asset's market price increases. The seller, on the other hand, will profit if the asset's market price decreases.

Figure 6. Value received by buyer A in the futures contract

Suppose A is the buyer and B is the seller in a futures contract. According to the contract, A must buy 1 unit of the underlying asset (for example, 1kg of rice) from B at the futures price F (12,000 VND) at the maturity date T, which is three months in the future.

Figure 7. Value received by seller B in the futures contract

After three months, when the contract expires, the market price of rice is S TAccording to the contract, A must

buy rice from B at price F. A can sell rice

market with price S T. The value of A received is ( S T- F) is represented by the upward 4 5 line at

drawing. If S T>F then A benefits from the contract, otherwise A will suffer a loss. According to the contract, B must sell to A at price F, B can sell to the market at price S T. The value B received from the contract is (F - S T) is represented by the downward 4 5 line as shown. If S T>F then B loses from the contract and vice versa.

We can see that the values A and B obtained are completely symmetrical.

3.2.3. Limitations of futures contracts in Vietnam

We see that futures contracts are a step forward from forward contracts, and are a useful tool for businesses in hedging exchange rate risks. However, because futures contracts are traded on the market,

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