The National Australia Bank

The National Australia Bank was founded in 1858 and was the first global network to be established in London in 1864. The bank has grown tremendously since the 1960s. This company specializes in banking services, housing and general finance, leasing, life insurance, investment banking, credit and access card facilities, international banking, funds management, and trustee, custodian, and nominee services. It has significant activities in Australia, New Zealand, the United States, Asia, and the United Kingdom. In this regard, the objective of this report to analyse the operational environment of National Australia Bank and introduce the right trading strategies for currency exchange rates to see it make profits. Notably, the global and local market analysis and forecast revealed the fundamentals that would impact the currency exchanges. The pairs proposed were the AUD/USD and AUD/EUR that when the Bank hit them on the left and later hit them on the right after six months period, and at the project exchange rates, the net position would be AUD 0.144M.

Introduction

The establishment of National Australia Bank was on 1858, before it began its international networks in London in 1864. From 1960, the Bank has experienced rapid growth and expansion. Among its main activities include banking services, housing and general finance, leasing, life insurance, investment banking, credit and access cards facilities, international banking, funds management, services of a trustee, custodian, and nominee. It serves Australian businesses, New Zealand, United States of America, Asia, and the United Kingdom. From the recent World's Safest Banks report, National Australia Bank was ranked number 22 overall (National Australia Bank Limited, 2017).

The purpose of this report is to analyse the operational environment of National Australia Bank and introduce the right trading strategies for currency exchange rates. The currencies considered are from the jurisdictions where it serves various customers, and include the Australian dollar (AUD), United States dollar (USD) and the Euro (EUR).

The report is organised into four major parts. The second section performs an analysis and the market view to forecast the likely movement in the exchange rates of the selected currencies. The third part addresses the trading strategies that will be adopted to ensure that the Bank makes returns from the exchanges. The section will also cover the risks likely to be experienced in achieving the set objectives and how they can be overcome. Finally, a conclusion will be offered on the noted points.

Market Analysis and View, and Trading Strategies

Market Analysis and View

In its 2016 annual review, the Bank noted that the global economic growth remained at the sub-trend speed with advanced economies recording below 1.5% year-on-year. The global sub-trend growth and the below-target inflation have made the oversight bodies such as the central banks to develop rules that maintain the interest rates at historic levels to stimulate the economy (National Australia Bank Limited, 2016, p. 15). The bank added that for the following three years, the global growth was expected to be below 3% with the US and some East Asia countries recording a modest increase, and India and China expected to be the critical agents of growth.

In its 2017 updated World Economic Outlook Report, the International Monetary Fund stated that the global cyclical recovery continued. The growth in the output of emerging, developing and advanced economies such as China, Mexico, Brazil, Canada, Spain, Germany, and Italy in the first quarter of 2017 superseded that of April (IMF, 2017). The high-frequency indicators, including the rise in the global trade and industrial outturn gave signs of continued strengthening of the global growth in the second quarter. The 2017 global growth forecast for advanced and, emerging and developing countries is 2% and 4.6% respectively while that of 2018 is projected to be 1.9 and 4.8 in that order. Precisely, for the advanced economies, the US growth rate was downward adjusted from 2.3% to 2.1%, following a weak performance in the first quarter of 2017, leading to the assumption that its fiscal policies would be less expansionary (IMF, 2017).

By contrast, the growth of eurozone countries such as Spain, Germany, Italy and France was revised upward as the high-frequency indicators showed that the output would remain higher than initially projected (IMF, 2017). The Czech National Bank's 2017 Global Economic Outlook report also noted that the euro area economic growth rose at its fastest year-on-year rate in the second quarter of 2017 in five years. The purchasing manager's indices in manufacturing and industrial production grew by 3.2% in a five-year run (Monetary Department, 2017). The labour market also remained favourable with low unemployment rates and annual wage growth of 2% from 1.3%. The inflation increased by 0.2% to 1.5%, but is expected to drop by 0.3% in 2018.

In Australia and New Zealand, the Bank stated that these economies remained favourable and attractive by global standards (National Australia Bank Limited, 2016, p. 15). The economy recorded a growth of 3.3% in the 2016 second quarter, being it's fastest since 2012. The service industries continued to be resilient, and the gross domestic product was estimated to grow by 2.7% in 2017 and slightly decline to 2.6% in 2018 as a result of a decline in commodity exports and housing construction. The Australia's mining sector remained weak and presented challenges to the country's income growth. The Chinese economy shocks aggravated the condition.

The USD has been defensive for much of the year, but now has its first three-quarters of the period decline moderated since September (Scotiabank, 2017, p. 3). Following this trend, this report forecast that the USD will remain better in the next weeks, probably to the year-end. The report predicts that the USD will benefit in the short run from the speculation that the Fed will lift the interest rates and the tax reduction will boost the country's economy. However, the currency's rebound may not necessarily be an indication that it will withstand long-term depreciation shocks. The USD appreciation trend noted in the past few years may reverse in the long run. As further added by Scotiabank (2017, p. 3), the USD recorded broader and deeper losses at the beginning of the year, as an indication that the global growth momentum was increasing and less monetary accommodation was available elsewhere, thereby undermining the USD's growth.

Between March and June 2017, the USD had depreciated by 3.5% in real practical terms, while the EUR had shown resilient by the same value due to the increased confidence in the recovery in the area and a reduction in political risks. The variations in exchange rates over the same period across the emerging market currencies remained relatively modest with the strengthening of monetary policies and reduced worries about the US trade frictions. The IMF (2017) added that the emerging economies experienced resilient capital flows in 2017. On this basis, this report presupposes that deeper USD drops may extend in the future.

Since early September, the EUR has weakened for two months, and it is likely to remain vulnerable as the bearish month of November has approached. The interest rates differentials present challenges, leading to an extension of speculative bullish EUR positioning. A Global Outlook Report by Scotiabank stated that the options market showed that the EUR was neutral in shorter time horizons and modestly bearish after six months (Scotiabank, 2017, p. 6).

The Scotiabank (2017, p. 6) noted that since August, the AUD remained weak, and was entering November slightly above its three-month low rate. Its poor performance was attributed to the interest rate differentials and weak iron prices. A speculation in its improvement has been extended, and the bulls were purchasing it.

Strategies

In FOREX markets, the exchange rate is used to define the negotiation price through which a simultaneous purchase of one currency and the sale of another takes place. Through these exchange transactions, one currency may lose value while another one wins. Morel (2004, p. 2) noted that the foreign exchange market participants remain exposed to risks. The risks arise because the exchange rate change over time since in commercial activities, there is always a time-lag between the signing of the contract and the payment time. Also, a company gets exposed to foreign exchange risks when it operates its subsidiaries under various currencies. Thus, several strategies can be utilised to earn good returns from the currency exchange. They include

The speculation strategy- arises where an individual or an entity purchases a foreign currency, not to invest or import, but for the hope that the currency may be sold at a higher amount in the future. In other words, the investor buys one currency to hold as it awaits its appreciation, best referred to as "buying low to sell high." One of the commonly known speculation strategies is the carry trade. The practitioners sell currencies forward with a forward premium and buy currencies forward with a forward discount (Burnside, Eichenbaum, Kleshchelski, & Rebelo, 2006, p. 1). According to Accominotti (2016, p. 72), the carry-trade arises when an investor borrows in low-interest currencies to invest in high-interest rate. As noted by Borzykowski (2014), the practitioners should look at the commodity market to get the undervalued currencies and purchase them, awaiting their appreciation that will eventually earn profits. Also, while speculating the currency, one should consider the inflation rates in one economy, relative to another.

The second strategy to use in minimising the exposure to exchange rate risks is hedging. Currency options are useful techniques for exchange risks management. Morel (2004, p. 4) noted that the currency options are instruments of a financial nature that give the holder the right to purchase or sell currency in a given amount at a future date. These tools are also valuable in protecting the wealth while avoiding useless transactions and unwanted costs. Clark and Ghosh (2004, p. 89) noted that besides using the currency options to hedge against the risks, they are very beneficial to participants who expect short-term currency movement.

The positions requiring currency hedging may be long or short with options being traded on foreign, as well as the domestic markets. The hedge is constructed by selling an option, buying an option or a combination of the two activities. Hedging a long position is a claim in foreign currency, and the strategies are symmetrical. For example, when hedging a long position by quoting the exchange rate regarding the domestic currency units, puts should be bought. On the other hand, when hedging a short position, a call should be bought (Clark, P. 90). Currency swaps are also used, whereby an exchange of a specified amount of currency is done by two foreign borrowers with varying needs through a financial intermediary.

Table 1. Selected pairs

Currency pairs 6/11/2017's range

AUD/USD 0.764 - 0.768

USD/EUR 0.8636 - 0.8606

From table 1, the exchange rates range for AUD/USD, and USD/EUR has been presented. It is observed that while AUD/USD slightly rose, the USD/EUR recorded a drop. Using the AUD/USD and the USD/EUR exchange rates, the AUD/EUR rate could range from 0.6597-0.6609. Following the fundamentals analysis and their likely effect on the future exchange rates, this report forecasts that the AUD/USD and the USD/EUR maybe 0.79 and 0.8475 respectively after the six months period. Consequently, the exchange rate of AUD/EUR would be 0.6695. Therefore, to be in a net exchange position, the foreign currency to be bought is AUD/USD and AUD/EUR. Other values will range between the forecasted values and those presented on the table. The National Australia Bank can perform the following trading activities to gain a profit.

Buy 3 million AUD at AUD/USD = 0.768

Buy 4 million AUD at AUD/EUR = 0.66

Buy 2 million AUD at AUD/USD = 0.77

Sell 5 million at AUD/USD = 0.79

Sell 4 million at AUD/EUR = 0.6695

Net position = {5M*0.79- (3M*0.768+ 2M*0.77)} + {4M*0.6695- 0.66)}

= 3.95M - 3.844M +0.038M

= 0.144M

Conclusion

The report has demonstrated how an entity can use various investment strategies to benefit from foreign currency exchanges. Through a market analysis and forecast, the thoughtful approach was used to select two pairs, AUD/USD, and AUD/EUR. At the end of a six months period, the National Australia Bank stands to get a profit ofAUD0.144M.

References

Accominotti, O. (2016). Foreign exchange markets and currency speculation: Historical perspectives. [Online] Available at

Borzykowski, B. (2014, April 2). 4 ways to protect yourself from foreign-currency risk. [Online] Available at

Burnside, C., Eichenbaum, M., Kleshchelski, I., & Rebelo, S. (2006). The returns to currency speculation. [Online] Available at :

Clark, E., & Ghosh, D. K. (2004). Arbitrage, hedging, and speculation: The foreign exchange market. Westport, Connecticut: Greenwood Publishing Group.

IMF. (2017, July). World economic outlook update. [Online]

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Monetary Department. (2017, September). Global economic outlook- September. [Online]

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Morel, L. (2004). Currency options and swaps: Hedging currency risk. [Online]

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National Australia Bank Limited. (2016). 2016 annual review. [Online]

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National Australia Bank Limited. (2017). About National Australia Bank. Retrieved from National Australia Bank Limited: https://www.nationalaustraliabank.com/nabglobal/en/about-nab

Scotiabank. (2017, November 3). Global economics & foreign exchange strategy. [Online]

Available at: