Goldman Sachs

[The Minsky Moment]

Yeah, which is their right. What I question is to what extent they should be allowed to actually influence FX rates by speculative selling/buying of large quantities of foreign currency on the eve of their bond/option pay out date, to jack up their profits.

With a floating exchange rate their "right" to influence FX rates is unlimited.

Subject to whatever rules against market manipulation may be in place.

[alfred russel]

Yeah, which is their right. What I question is to what extent they should be allowed to actually influence FX rates by speculative selling/buying of large quantities of foreign currency on the eve of their bond/option pay out date, to jack up their profits.

With a floating exchange rate their "right" to influence FX rates is unlimited. 

I'm not positive but I think what you described (making money by buying options then buying/selling in the spot market to move those options into the money) is impossible.

That's not how it worked.

Before financial crisis, banks offered a lot of hedging instruments against fx risk associated with, say, Polish zloty continuing to raise against US$. Now when these instruments became due, they flushed a lot of zlotys into the market, thus artificially reducing it value - which gave the banks big returns on the hedging instruments.

While consipiracy theories are on occassion right, doesn't it seem more probably that eastern european currencies have lost value because:
a) in a crisis, the dollar and the euro are seen as safe haven currrencies, and
b) Eastern Europe is seen by more than a few as the most exposed region in the crisis

[The Minsky Moment]

That's not how it worked.

Before financial crisis, banks offered a lot of hedging instruments against fx risk associated with, say, Polish zloty continuing to raise against US$. Now when these instruments became due, they flushed a lot of zlotys into the market, thus artificially reducing it value - which gave the banks big returns on the hedging instruments.

That sounds like the banks were involved in legitimate business activity, providing hedging services to clients.

I am also a little confused about the mechanism here.  If the banks are hedging against a zloty rise and they turn out to be on the correct side of the trade (the zloty falls or remains steady), and if the hedge is in the form of an option (as per your post), then presumably the customer will just let the option lapse, and the bank keeps whatever premiums it earned.  How does that flush zlotys into the market?

[Martinus]

Yeah, which is their right. What I question is to what extent they should be allowed to actually influence FX rates by speculative selling/buying of large quantities of foreign currency on the eve of their bond/option pay out date, to jack up their profits.

With a floating exchange rate their "right" to influence FX rates is unlimited. 

I'm not positive but I think what you described (making money by buying options then buying/selling in the spot market to move those options into the money) is impossible.

That's not how it worked.

Before financial crisis, banks offered a lot of hedging instruments against fx risk associated with, say, Polish zloty continuing to raise against US$. Now when these instruments became due, they flushed a lot of zlotys into the market, thus artificially reducing it value - which gave the banks big returns on the hedging instruments.

While consipiracy theories are on occassion right, doesn't it seem more probably that eastern european currencies have lost value because:
a) in a crisis, the dollar and the euro are seen as safe haven currrencies, and
b) Eastern Europe is seen by more than a few as the most exposed region in the crisis

In February, Polish zloty fell by almost 20% over 2 days, which was coincidentally right before a number of hedging options expired.

It since when has regained enormously and is now back to its November levels.

[Martinus]

That's not how it worked.

Before financial crisis, banks offered a lot of hedging instruments against fx risk associated with, say, Polish zloty continuing to raise against US$. Now when these instruments became due, they flushed a lot of zlotys into the market, thus artificially reducing it value - which gave the banks big returns on the hedging instruments.

That sounds like the banks were involved in legitimate business activity, providing hedging services to clients.

I am also a little confused about the mechanism here.  If the banks are hedging against a zloty rise and they turn out to be on the correct side of the trade (the zloty falls or remains steady), and if the hedge is in the form of an option (as per your post), then presumably the customer will just let the option lapse, and the bank keeps whatever premiums it earned.  How does that flush zlotys into the market?

No, THAT doesn't flush zlotys into the market. The banks would flush zlotys into the market (by selling lots of their zloty reserves), thus bringing down its price, thus earning big premiums on their options.

[The Minsky Moment]

[No, THAT doesn't flush zlotys into the market. The banks would flush zlotys into the market (by selling lots of their zloty reserves), thus bringing down its price, thus earning big premiums on their options.

The premium is whatever it is when they entered into the contract.  So only way for this to work is if the options had been in the money but then the banks took them out of the money by flushing some reserves into the spot market.  That strategy could only work if a relatively small amount of trades on the spot market could move prices and make them stick - i.e. if there is significant illiquidity in zloty-$ or some kind of barrier to trading.

this scenario also only makes sense if all the banks had entered into contracts with similar sunset dates.

[alfred russel]

That's not how it worked.

Before financial crisis, banks offered a lot of hedging instruments against fx risk associated with, say, Polish zloty continuing to raise against US$. Now when these instruments became due, they flushed a lot of zlotys into the market, thus artificially reducing it value - which gave the banks big returns on the hedging instruments.

That sounds like the banks were involved in legitimate business activity, providing hedging services to clients.

I am also a little confused about the mechanism here.  If the banks are hedging against a zloty rise and they turn out to be on the correct side of the trade (the zloty falls or remains steady), and if the hedge is in the form of an option (as per your post), then presumably the customer will just let the option lapse, and the bank keeps whatever premiums it earned.  How does that flush zlotys into the market?

I don't know for certain, but I would guess that currency hedges through forwards, futures, and swaps would be more common than options. All of the former could involve mechanisms with an incentive like the one Marty is discussing.

[alfred russel]

Yeah, which is their right. What I question is to what extent they should be allowed to actually influence FX rates by speculative selling/buying of large quantities of foreign currency on the eve of their bond/option pay out date, to jack up their profits.

With a floating exchange rate their "right" to influence FX rates is unlimited. 

I'm not positive but I think what you described (making money by buying options then buying/selling in the spot market to move those options into the money) is impossible.

That's not how it worked.

Before financial crisis, banks offered a lot of hedging instruments against fx risk associated with, say, Polish zloty continuing to raise against US$. Now when these instruments became due, they flushed a lot of zlotys into the market, thus artificially reducing it value - which gave the banks big returns on the hedging instruments.

While consipiracy theories are on occassion right, doesn't it seem more probably that eastern european currencies have lost value because:
a) in a crisis, the dollar and the euro are seen as safe haven currrencies, and
b) Eastern Europe is seen by more than a few as the most exposed region in the crisis

In February, Polish zloty fell by almost 20% over 2 days, which was coincidentally right before a number of hedging options expired.

It since when has regained enormously and is now back to its November levels.

Falling 20% in 2 days sounds fishy, but then February was a crazy month. Just taking the US stock market as an example, we fell dramatically during that time period too (but not 20% in 2 days) and are now back to November levels as well.

[The Minsky Moment]

I don't know for certain, but I would guess that currency hedges through forwards, futures, and swaps would be more common than options. All of the former could involve mechanisms with an incentive like the one Marty is discussing.

One way or another you would have be talking about some kind of obligation to deliver zlotys.  I don't see how any currency dump could work here unless the market is \weak and subject to easy manipulation.

[alfred russel]

I don't know for certain, but I would guess that currency hedges through forwards, futures, and swaps would be more common than options. All of the former could involve mechanisms with an incentive like the one Marty is discussing.

One way or another you would have be talking about some kind of obligation to deliver zlotys.  I don't see how any currency dump could work here unless the market is \weak and subject to easy manipulation.

I would guess that many if not most currency forwards/futures/swaps have net cash settlement features, so zlotys wouldn't need to be exchanged. Suppose I am a bank writing forwards to hedge companies who have used american debt to finance operations in poland.  If we have a forward agreement with a net cash settlement feature and you pay theoretical US$1 while my bank pays theoretical 3 zlotys on settlement, I have an incentive for a devalued zloty on settlement. For example, if the exchange rate on settlement date is 4-1 (versus the implied 3-1), you will owe me $0.25 (assuming US dollar settlement). There wouldn't be a need for anyone to touch zlotys as a part of the contract.

[Admiral Yi]

I don't know for certain, but I would guess that currency hedges through forwards, futures, and swaps would be more common than options. All of the former could involve mechanisms with an incentive like the one Marty is discussing.

Do forwards, futures and swaps involve payment of an up front premium?

How does an FX swap work?  Never heard of it before.

[alfred russel]

I don't know for certain, but I would guess that currency hedges through forwards, futures, and swaps would be more common than options. All of the former could involve mechanisms with an incentive like the one Marty is discussing.

Do forwards, futures and swaps involve payment of an up front premium?

How does an FX swap work?  Never heard of it before.

They can, but they typically don't involve an upfront premium.

An fx swap works conceptually like a forward but involves a stream of payments on a series of dates rather than a single payment on a single date.

[The Minsky Moment]

I would guess that many if not most currency forwards/futures/swaps have net cash settlement features, so zlotys wouldn't need to be exchanged. Suppose I am a bank writing forwards to hedge companies who have used american debt to finance operations in poland.  If we have a forward agreement with a net cash settlement feature and you pay theoretical US$1 while my bank pays theoretical 3 zlotys on settlement, I have an incentive for a devalued zloty on settlement.

I don't dispute this, but I don't think it changes my analysis.

[alfred russel]

I don't dispute this, but I don't think it changes my analysis.

Having a net cash settlement feature disconnects the contracts from an actual transaction in the currency, which means you are settling multi-million dollar contracts based on numbers in the wall street journal or financial times. Intervening to manipulate those numbers seems a bit less far fetched, but in the end I agree with you that it still seems far fetched for the reasons you posted.