What is the rationale of the double-play strategy, Financial Management

Q. What is the rationale of the double-play strategy?

Hedge Fund enters agreement to sell HK$ in six month's. At expiration the Hedge Fund requires to buy spot HKD and deliver these against the short future's position.

If the peg embraces the cost of replacing the HKD it has sold is fundamentally the 6 month differential between USD and HKD interest rates.

On Thursday August 20th the dissimilarity in inter-bank interest rates was about 6.3% Hong Kong rates being higher due to heavy demand for HKD loans which are needed to short the currency. Consequently a hedge fund manager making a USD 1 million bet Thursday against the HKD would have paid USD63000.

If the finance manager believed that the peg would break and thus the HKD depreciate say about 30% then the potential profit would be USD300000. Evaluated to the cost of making the trade USD63000 this is a good profit.

MA Intervenes HKMA interfere to defend the peg. Utilize its own FX reserves MA sold USD. Usually when a country with a pegged currency spends reserves to defend the currency's value the intervention will have to be sterilized. In other sense the central bank would purchase local currency bonds from the banking system. The purchase will be roughly in alike quantities so that the overall monetary base remains constant.

Nevertheless doing this in Hong Kong at that time would result in further increases in interest rates. This would be considered as harshly harmful by real estate companies in Hong Kong.

What is the rationale of the double-play strategy?

The hedge funds deploy a double-play strategy in order to engineer steep increases in interest rates and steep declines in stock prices so as to gain from their short positions in the stock market and in the FX futures market.

However first some comments about the economic conditions prevailing at that time. In untimely August of 1998 external and domestic conditions deteriorated. The Dow Jones index refuse sharply by 300 points on August 5th and the Yen was at an eight year low at 147 on August 11th. Rumours were plentiful concerning abandonment of the peg. There was powerful selling pressure on HKD early August.

1. Entrepreneurs shorted the HKD by swapping HKD for USD.

2. On the equity markets the stocks index futures market open positions grow brusquely

The HSI FUTURES rise from 70000 contracts in June to 92000 contracts in August. The strategy of the Hedge Funds was to weaken the steadiness of the exchange value of the HK$ consequently as to produce sharply higher interest rates.

The sharp raise would then lower stock prices it was hoped. Hedge Funds sell HKD. This raise HKD interest rates(r). Such high interest rates can't be tolerated by property developers. Real Estate companies undergo serious losses and their stocks decline sharply. The HSI goes down as the HIBOR goes up. At this point one more strategy is to short sell borrowed shares. So far the existence of futures markets makes this redundant. A speculator is able to short the HSI index instead.

Posted Date: 7/22/2013 2:48:30 AM | Location : United States

Related Discussions:- What is the rationale of the double-play strategy, Assignment Help, Ask Question on What is the rationale of the double-play strategy, Get Answer, Expert's Help, What is the rationale of the double-play strategy Discussions

Write discussion on What is the rationale of the double-play strategy
Your posts are moderated
Related Questions
What creates the APV capital budgeting framework useful for analyzing foreign capital expenditures? The APV framework is a value - additivity method. Since international projects

Question : (a) A company wants to purchase a plant for its expanding operations. The desired plant is available at Rs 300,000 in cash. Alternatively, the company has the option

Q. Describes the methods of Capital Budgeting? Capital Budgeting: - Capital Budgeting is the procedure of making decisions for investment in long-term assets. It is a method of

Fraud and Society and Analytical Techniques: Fraud and Society - The effects and financial consequences of fraud in society including the individual, older people, financial

Define the meaning of procurement Term procurement was used in a broad sense so as to include the whole gamut of raising funds externally.

Medium-term notes are debt instruments that can be offered continuously to an investor. An agency of the issuer offers these; and these are avai

We can measure the convexity with the help of following formula:                                                                              ...Eq. (4) Where,          Δ

Explain the methods used to treat the obsolete stock Review Inventory for obsolete items Make materials review board Include an obsolescence review in the closing p

Financial management is that division of managerial process which is concerned with the planning and controlling of firm's financial resources. It is concerned with the procurement

What is the debt security in the financial term? Debt instruments are instruments which promise the payment of specified sums to the investor. Illustrations of debt instruments