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Hedging 101

We finance folks have the propensity to confuse the heck out of everybody on simple terms (or issues) relating to finance. We will sit around talking derivatives lingo and other market issues like its alien- speak to others – it really, is not! I usually say to people:

•It is not that difficult

•If I cannot explain my model, in words – i.e. what the model is, what is does and how it does that, I have no business just plugging in numbers, “letting it calculate”, then looking at a number and saying “Well, this number means XYZ” – that is utter nonsense and is one of the reasons why the financial mess in 2008 happened – people not knowing more than just “that number”!

•You must interrogate what the terms and ensuing numbers and operations mean – if you don’t understand exactly what an ABS (Asset Backed Security) is, what it does, how it works, what the end result is intended to be, variations to, relation to other market variables – seriously, you have no business, just “doing ABS “on the quantitative front – because really, what the heck are you doing?

•The market place is very dynamic; what worked in 2007, might still be relevant today (or not), but certainly needs analyzing to ensure it still fits! That business of “this is how we do it” – yah, that doesn’t hold water for serious minds.

Simply stated at first – and I intend to go into detailing in subsequent posts to explore the different facets pertaining to hedging. (I hope to be a better blogger in 2013 – because I am always writing something, someplace anyway!)

So, Hedging:

What is? Hedging is simply the practice (art and/or science) of minimizing losses in your portfolio. It will mean, you make an investment of some kind to ensure that the value of your assets is protected from adverse price movements in the market.

Simple!

All you are trying to do is ensuring that at the end of it all, your $1 is at least still equal to $1 and not $0.98. The goal of course, it to ensure that your $1 yields some profit, but at the very least, you are not trying to lose any money, no matter what the market dynamics are.

Why?

We hedge because of imperfections in the market; ideally, prices should adhere to demand and supply forces. They do not (sometimes, most times actually!) and there is therefore, the potential to make lots of losses if we do not employ strategies (hedging), to accommodate for the volatility in the markets. We therefore hedge to minimize risk exposure in markets (and hence maximize opportunities presented by these very same financial risks, while factoring in the cost of the hedge). We hedge to manage market risks – in a nutshell.

What do we hedge?

Commodities (agricultural or non-agricultural), credit risk, currencies, interest rates, weather (yes, we do have weather derivatives) etc.

How do we hedge?

First you must consider the general organization’s policy and objectives on risk management. This would include types of hedging employed, limits and other guidelines that define the what to do and what not to do as far as hedging is concerned. This is absolutely important, because hedging can never provide cookie-cutter solutions; it is a subtle balancing between market dynamics and organizational objectives. It must be what works for you (which is why as a consultant, I can never, ever recommend generic hedging strategies for a company without understanding the key underlying issues of that company, in relation to market dynamics at a particular point in time while anticipating expected future results and trends)

Then, you develop a strategy that works or you (and I will be detailing specific hedging strategies in follow up posts), and implement and monitor said strategy (usually will be a combination of various methods). You will need to have a strategy that is viable both qualitatively and quantitatively – Like I observe, if doesn’t make sense in words, it probably will not in numbers!

I find that proper documentation of hedging (and risk management strategies as a whole) is imperative to ensuring constant review of implementation, controls and adjustments.

Some forms of hedging will include (but not limited to): futures contracts, options, swaps, forward contracts, EFTs etc) as applied to commodities, currencies, interest rates etc.

My next post will focus on better definitions of some of the terms referenced to in this post……Then we will keep going. Happy 2013 folks!

Apparently or evidently, trying to explain, not the definition kind of explaining, but the “what exactly does that mean kind of explaining” on different issues in futures and commodities trading, in Kenya, can take one 3 years – and counting.  Quite understandably so because: Unless you have had an opportunity to have a hands-on experience with issues in Futures/Commodities trading, all you will have is theoretical know-how – which will not really translate to much in the short term. But folks aren’t even trying – and that’s what’s exasperating! Let’s all take that theory from finance and MBA classes and begin to understand it!

 

We have been expecting to have a Futures Market in Kenya since 2009 – word has it, we will have one “soon”. Whatever that means! So the CMA has somewhat restructured to be in line with this “soon deadline” by appointing a manager for the upcoming Futures Exchange. As of April 2012, the search for consultants to draft trading and oversight rules for the proposed exchange was still on. Again, a move I can understand because unless the Exchange is well structured, in line with International Best Practices (pardon my use of MBA – type redundant terminology like “best practices”!), we probably will not achieve much from it.

 

Maybe, instead of trying to find “a” consultant to structure the entire exchange, the CMA could, break down the different facets comprising an Exchange and find consultants for those. An exchange will need to define everything from front to middle to back office and different things must be addressed: structuring of contracts (pricing, contract types, how they trade, expiration, margining, clearing, reporting, delivery, settlement etc) regulatory structures, taxation issues etc.

 

In my opinion too, the CMA will need an “arm” that will, solely be tasked with addressing issues of the exchange – something like the NFA (National Futures Association) and CFTC (Commodity Futures Trading Commission) in the US. The complexity of issues in futures and commodities exchanges, mandate separation of regulatory mandate, if full benefits of the exchange are to be accrued by participants.

 

As we contend with the pre-Futures Exchange issues, we will continue to grapple about price volatility, price discovery, price risk management (hedging), lack of another asset class presented in a futures exchange etc – things the current market will not adequately address with the absence of a well structured and regulated Futures Exchange.

 

In the meanwhile, I still continue trying to explain that a CTA (Commodity Trading Advisor) is not a Brokerage Firm. A CTA will generally give advice on trading of futures and options (for compensation) including but not limited to having actual trading rights on client accounts.  A Brokerage on the other hand will be the “facilitator” between the CTA’s, CPO’s (Commodity Pool Operators) and other individual and institutional clients AND the Futures Exchange. In the US, this would be a FCM (Futures Commission Merchant). We need to get this right, because we will need to be registering come CTAs, CPOs, and FCMs etc.

 

The Bourse Africa – that is to be the 1st Pan African bourse for commodities and derivatives will commence its operations in October 2012 (finally!). Maybe, the CMA, can go on down to Botswana for some “best practice” knowledge share?

Clearly, I am not a very serious blogger! This is my first post this year and the year is not exactly young! It called having a lot to do ( ok, everyone I know has a lot to do), but really, for me I think it is a lot to do compounded with the fact that I have been forced to be a lot like an Octopus since mid last year. I have no complaints because I have been stretched as a person – and I have grown (cliché, but no so much so)

So much going on, but some things I have realized about some of the experiences I have been through is that:

One – there is a special place in hell for doctoral supervisors (I kid you not! I’m sure some day I will have some candidates saying that about me, but at least I will not believe its just hot air – they actually do have valid arguments for),

Two – I am a capital markets girl – give me a treasury department, derivatives, liquidity management, ABS/MBS issues, Foreign Exchange Issues (hedging, transactions, sweeps etc). Stress testing, financial modelling and a fast paced multi cultural environment and I will FIT right in! It has been a time of balancing my passion and my abilities. I have a knack for financial market issues that is just inherent and I am no longer “scared” to admit that! So feel free to share – that there is a woman I happen to know that loves market issues hook, line, sinker!

Aside: The recent spike in gas/fuel prices in Kenya by at least Ksh 10 prompted very spirited debates between my friends and I on various social media networks. At one such discussion, a “prominent” business journalist gave a very simplistic, almost dismissive remark about who we should blame. He simply said, there is a need to realize its all about taxation and blame should be solely on government. Maybe – but that’s an answer you expect from those “tunaomba serikali (we ask the government)” mindsets – NOT a business journalist! Very annoying! And embarrassing.

As one who has worked in global financial markets to include a long stint in Oil and Gas…..I was very perturbed, shocked or whatever that such a callous remark can originate from a business analyst that a lot of Kenyans look to for analytical perspectives! And who doesn’t know that when it comes to crude oil, so much more is at play than just government and taxation? (Maybe I will write a post of this!)

Three – In life, you can’t be scared/ashamed of re – aligning your priorities or business models when you realize things aren’t quite working as you wanted or expected them to. It takes a brave soul/spirit to embark on plan C,D, E or even F – they could be detours that will the IT!

Lastly, my apologies to all that have contacted me personally via email concerning one or two issues on this blog – Please bear with me and you will be getting a response in a day or two. I am humbled that though I don’t publish much these days, someone still finds something relevant on my blog! I want to remain relevant to myself, my readers and to current happenings in our beautiful lives.

Great week to everyone!

Heteroskedasticity

Yes, I actually do remember Business School 🙂 even though I am doing something very non-MBA right now. ( As in, I no longer sit at a desk, watching crude oil futures prices graphs on the NYMEX and doing a whole lot of market analysis stuff and whatnot! I don’t “worry” so much what the USD/CAD, USD/EUR is doing etc – that’s what I mean) And no, this is not entirely a finance article, well it is somewhat!

The highs, the lows, predictions, rallies, cycles what not…. I am not entirely sure if I miss my life in finance or if I don’t; what I am sure about though is that I am so very passionate about what I am doing right now, and that I will also never really “de-link” myself from financial market happenings. More so, I have derivatives etched very deep into my DNA :-), and intend to get a lot of billable hours out of what I do know about them 😉

So back to Heteroskedasticity (if you don’t know what that means please look it up – its part of the fun to this piece). Lately, I found myself thinking about a situation I was dealing with and the only term that aptly and jumped out at me, to describe the un-said situation is this word. Trust me I am not “geeky” or anything but I found myself just thinking “Heteroskedasticity” – like I was about to take the CFA or Series 63 or something!

Anyway, surprisingly, it kind of settled me down because I realized I was dealing with something that I had no power to “control” in entirety….so I kept it moving. I also realized that even those parts that I could predict, I really could not, with precision; determine what the outcome would be – just like financial markets don’t you think? How many solid models have totally backfired on ingenious market gurus huh!

You unleash volatility in markets and you can’t exactly tell where it’s all going to end. Or can you? (Somebody that has please share!)Last year, at my last position, I attempted to understand implied volatility in derivatives trading; I did get a model going (but without factoring in the volatility part, meaning I had to rework many variables backwards and the LONG way!)….I quickly realized that had I had a solid grasp on volatility, then my model would have taken me much much much less time to build! BUT, I am not doing a PhD in Econometrics – and for good reason. Hahaha!

Anyway, my life right now is rather “volatile”, even erratically volatile sometimes. I can’t predict for sure what, when, how its all going to happen – but I am taking it in stride. The one thing I can predict though, is that I am not allowing de-railers into the already very “aggressive cycle” and that all shall come together!

Yes, I am a realist! And one that believes that everything that happens in my life is for a reason….

Note: This is a note that I should have posted months ago……but have never quite got around to doing it! But here I am now…

Oprah usually says “never talked about before until now”, and I am following suit – folks, hot off the pan (I love cooking!), here comes:

One lovely evening, Mr Man walked to Ms. Woman’s apartment and “ended” whatever had been going on between them for a while – or as far as Ms Woman was concerned – He ended a relationship between them. Just like that. Reason. “You are too focussed and independent and I don’t want to derail you” – a laughable thing, but not very funny at that particular moment. Ms. Woman refused to apologise for being “focussed and independent”, and said so in both words and by choosing to go on with her life (after dealing with it of course; and for some time). Nway, today, she is a fierce (r) woman with no apology about having a mind of her own and refusing to let people walk over her.

And good people, the above scenario is actually an account of something I went through a few years ago – that I really do not talk about .I blog about this years down the line not because I am all reminiscing about whatever, but because, it keeps getting reinforced in me, that, that is probably the best thing I ever did for my life – the refusing to act “blonde” in order to “keep my man”. I can bet you had I gone the “what-did-I-do” route, my life would be radically different from how it is today…radically different in ways that totally suck…..

– BUT of late, there has been too much talk about independent women etc, some people around me have voiced their sentiments about my being “too independent” and I found my mind wandering to instances that have been alluded to in that respect, as concerns me, in the past. I have also been branded a “woman of the caucus” – Kenyans will get that etc – Like that is a bad brand – thanks for the good PR ya’ll hateful, self doubting people hahaha!

Disclaimer: I am not a relationship expert, a shrink, men/women guru et al; I am just one woman that has a very perceptive mind, eyes that are wide open and ears that work – and a blog where I can write what I think without having to worry about being PC( Politically Correct – Sic!) Lol!

I don’t know if it is just me – maybe it is, but then again, hey, its about what I have observed and maybe actually gone through right?

A recent study, “revealed” – ok pardon my cynicism about the alleged findings, especially seeing I am also currently involved in academic research and is finding out all kinds of things that actually are against commonly held truths

Aside:
Like did you know that some of the purported micro-credit schemes are actually making some beneficiaries worse off than they initially were? As in some members are actually in debt coz they have to borrow money from elsewhere to be able to sustain themselves in some schemes intended to empower them economically – its either a case of poor product research and management, inadequate research and/ or follow up of implemented schemes or simply a case of we-know-but-give-a-blind-eye-to, by the stakeholders that stand to gain? (Story for another column though!)

Nway, I was saying – a recent study revealed, that there is an increase in the number of divorce cases in the age bracket 25-35 because there is a decreasing number of alpha males and increase in the number of independent women. I would say that is probably a co-relation that would make sense and I won’t challenge the findings because I am not privy to the research factors.

But – what got me going was this…why is there an increasing number of “independent women” – I put that in quotes coz people define an independent woman in very broad terms – no pun intended!

Case in point (a real life story by the way), a man and a woman – child hood buddies, currently aged 36 and 35 respectively. Both hold advanced degrees, one a sort after tax attorney the other a senior vice president at global blue chip firm. They both own their homes in affluent areas of the cities they live in et al – basically, they are doing “good” judged from their careers and lifestyles…AND they are HAPPY with their lives….someday, they both hope to find suitable wife/husband to raise families with – or not – they are open minded about their options for having a family – there is adoption for example.

Personally, I am thrilled coz these two are both my friends and I am so grateful to God that we have each other in our lives…they inspire me each day coz they have worked their asses off to get to where they are…and I always tell them – when I am 35 and 36, I want to be like you – not in the truest sense of the word, but coz I am equally ambitious and am glad to actually know that if I keep doing what I am doing – I am on the right track…..Plus – I am also realistic and honest enough to admit to myself the “kind” of success that I want….

Aside:

You know sometimes, people are “shy” to admitting what kind of success they want because of societal repercussions – For instance, people wanting to have a big family with one of the parents staying at home cease to do so because their neighbours are going to think they are “weird”, people wanting to have healthy bank accounts and assets to fall back onto for a long time refrain from doing so because they are going to be branded materialistic etc. The best place in life comes from knowing that only you are living in your skin so it matters not what the next person “feels” about your choices in life. Get liberated already!

Fast forward to “larger society”, my 36 year old, male buddy (John) is a success story and any woman would be “lucky” if he was her husband. Flip-side – my 35 year old, female buddy (Jane) is “too independent” – I mean what man is going to be able to “keep up” with her?

Correct me if I am wrong, but does it not come to some age that, man or woman, you are able to do some things for yourself? I mean if, like in this case, Jane has an illustrious career that she loves, has the money to afford the kind of lifestyle she wants and lives it and is happy about it – why should I, or worse still, “society” care what she does or doesn’t do!

And why is she coined negatively as “independent” because of taking care of her business? The reality is – she SHOULD be able to take care of herself, she CAN take care of herself and she CHOOSES to take care of herself – But my friend will not hear the last of her “kuwa na kichwa ngumu” until Mr Man comes along – Sigh!

Don’t we all have enough of our own issues to take care of to keep worrying about others? – I know I do!

Don’t get me wrong – there is a degree of participation that comes natural as a person that lives in a particular environment – we do not live in voids – but surely there is a thin line between being a responsible citizen and blatantly being up in peoples business at the expense of your own goals, ideals and life challenges. BUT, like I said – at the end of the day – it is about personal choice – and I choose to expend my efforts to those things that at the end of the day will make me a richer person – in the truest sense of the word.

Cheers to all the Independent Men and Women in my life – those that appreciate that this here, isnt a game of who is “better” – but rather a level playing field of “I am me, you are you, lets get this thing called living together going” 🙂

If you ask me – Kenya is ripe for a formal Futures and Commodities Market/Exchange.

It was reported (and I paraphrase), that we have had a 561% increase in milk production since 2003 – exponential growth! The milk handling agencies are hard pressed as to what to do with all this milk ( Duh – seriously!!!!!) There is talk of an expected bumper harvest in Eastern Kenya (note that this is an area that is usually drought- stricken, but thanks to donor seed provision programs, people are actually talking about bumper harvests), prices of food are falling due to surplus in markets and farmers are complaining of losses……

Flip- side: People are dying of hunger in some areas in Kenya.

Where is the balance? Isn’t it about time we had a Commodities market in Kenya? I believe so….

For those that know I am out of Financial Markets for a minute working on something that is near and dear to my heart. For those that do not know – this post here will help shed light on that….

I have put Margin Analysis, trading account structuring, Month End Close Cycles, Reconciliation and what not on hold for the minute I am “away” from financial markets – for now! I know I will work in Financial Markets sometime soon or in the future in some capacity, because after all, I have a flair for (I am just saying lol! :D), but my attention right now is focussed elsewhere and I intend to give that 110%, heart and soul.

Nway – that being said – I find it entirely difficult to dis-engage myself from what is going on in markets, or my friends make it difficult for me to do so hahaha! Someone ( I will not mention names :-)), told me I have 2 options concerning my “relationship” with markets – either get a restraining order or get married to them…..I chose neither and instead decided I will have an “affair” with markets ( NYSE, Futures, Commodities and Derivatives et al) and hope “my guy” ( what I am currently immersed in) , doesn’t get jealous.

If you are a proactive mind out there that believes we can get to getting to a commodities market – please begin the “Think- Tanking” Process and holla at me to join you. Seriously! I know for a fact that I do have something significant I can contribute towards that end….

There is not a good reason for having such losses and food asymmetry in the country when we can manage our resources, potentially very effectively with a commodities market.

Please take a minute to read my blog post on Futures Markets in Africa and subsequent comments and I think a lot of us think its about time – now for some action!

So, my poor blog has been thoroughly neglected, but I have been on a good cause! Happy 2010 people! Maybe a little late in coming seeing as its February and all 🙂

It’s been a hectic busy and very eventful 5 months (that is how long I have been back), but I feel like I have been here forever – nimekuwa mwenyeji tena – complete with driving amidst mad matatu drivers on bad roads, sitting in a matatu with blaring music I do not understand ( ama ni uzee? Lol!) It is a little different when you are back visiting for a few weeks, and it is a totally different scenario when you are back for a little longer – as in my case. I say “back for a little longer” because I have yet another part of my “relocation” that I will be going on in the near future that will be my next 4-5 years. That will be talked about when it happens.

Holiday season was very eventful and exciting! All of us were home together for the first time in 10 years. And it was an experience I would not trade for anything! Then its amazing that 10 years ago, we were kids and this time around, there were grand-kids for my mom- talking-too-much, running around grown grandkids!!! Blessings, blessings! Of course, for the first time in many years, I got to enjoy my holidays, winter – free! No winter coats, no scarves, mittens, no snow, no ice – just good weather! (Though it rained a little too much this time around) –Bliss!

I am very humbled and pleased to announce that, together with some people near and dear to my life, heart, dreams, visions and goals, we have founded a Foundation that is geared to developing young female entrepreneurs. We are specifically targeting young disadvantaged girls and our goal is to equip them with a skill and training that will alone enable them go “out there” and be self sustainable. We are absolutely not training the young girls to go out there and look for a job, though that is a choice they will ultimately make for themselves – there is a very serious paradigm shift going on globally and Kenya has not been left behind.

Entrepreneurship is it!

My Doctoral Research will be on Female Entrepreneurship as I had alluded to here so, as you can all see, I am finally, finally, after many years in Financial Markets, beginning to live my passion and that is something that I am profoundly grateful for. Baby steps but I am very confident that our vision at the Foundation is coming alive in a big way!

So besides fine tuning documents for registration and grant presentations, building our initial office facilities (read haggling with Kenyan Fundis that are seasoned to look down on wanawake), extensive travel, getting sick three times, serious networking ( I have talked to people I have never thought I would talk to and folks – its been quite an adventure) – it’s been fun.

I am very picky and detail oriented but I was occupied with other things and didn’t have the time to sit and type up constitution, drafts etc so I had someone do that for us – BIG mistake! Gosh – I got the first drafts and I used very many little words (bearing in mind I am the “polished type” that doesn’t curse). Yaani there were so many mistakes, I wanted to beat someone up! Then I realized, well, I better do this myself – and that put me about 3 months behind schedule because I was basically re-working a lot!

We are working on the Corporate Blog for the Foundation (as we work on the website etc) and I should send a link in a few weeks – so much to do! By the way, for those that do not already know, Social Networking is the in-thing. Yaani nowadays, you can do some facets of business efficiently via just a corporate blog (if well thought out) and even on Facebook. I am not surprised, because I have seen first hand what and how such avenues as Facebook and Blogs can be used in a very powerful and positive way.

Of course, we have issues we have to deal with, like any organization, but we are taking it one step at a time and realizing that Rome was not built in a day. We are taking the things we have to deal with in stride and in line with our mission and our vision.

As Executive Director, boy, the curve balls come each hour! And I realize that people want answers from me! It is greatly shaping me and with each day that lapses I am learning so much. I am no longer in a position where I can just leave and hope that someone gets the job done for me – I have to go out there and get things done. Very exciting, nerve wrecking BUT fulfilling! I knew it wasn’t going to be a piece of cake when I resigned from my Treasury job in the US, and it was something I knew I wanted and had to do – so help me God.

My Mom deserves special mention here – she seriously has been there so so so so much! I WOULD NOT have been able to do this without her support: emotional, moral, spiritual, networking (she knows everyone!) and financial support! She keeps telling me I can do it – and that keeps me going!

There are going to be subsequent posts concerning this (moving back), coz there is so much I want to write about but cannot do so in one post so watch out for, but be patient – Lol! And I hope I will actually get to doing that.

There are 2 things that I want to quickly mention though.

My friend ( and my once roommate in Kansas when we were in Grad School) and I were going for a latte at Savannah in Down town Nairobi and walking down the streets, we bump into this guy that was also living in the same city with us that now works with my friend in Nairobi. During dinner, as we caught up, we were amazed at just how many of us that were living abroad are now back home either working or running our own businesses.

The beginning of the end of brain drain? Maybe.

But one thing I am thankful for is that I am not back to Kenya to “look for a job” per se. I think that would be a very exasperating and novel idea for me right now.
I personally know of about 10 Africans (in professional jobs in the US, UK and Canada) that have been back to their countries in the past year. And I know of a good number that are returning in the coming months.

The second thing I want to note is that I have observed and gladly enjoyed the fact that there are a good number of young Kenyan women “doing their thing” back here. Some are married and have families, some are single and have no children, and some are single parents. In all these situations, I have had an opportunity to interact, in my three months back, with some seriously fierce Young African Women who know what it is they want in life and are going after it. The complacency that was previously held about and concerning us is just simple no longer in existence.

There are still some weirdly insecure and sick men and women out here, that still perceive young women or just women in general in the patriarchal idiocies that defined our (African women’s) place in society, but like I like to say – there are some things that are so etched in people’s DNA’s hakuna haja trying to change them.

A man, a grown Kenyan man, we were consulting on some technical aspects of the Foundation at one meeting told us there are some things a Kenyan Woman cannot simply do and needs a man to do them. We thought it was a joke in bad taste and let it slide that time considering the business at hand – big mistake! (Out of the 7 Trustees, 4 are women). That guy said the same thing in a subsequent meeting and we respectfully told him we no longer needed his services – chauvinistic idiot! I wonder if he has a wife or daughters!

And surprisingly, these self proclaimed, know it all, save the world men are the same ones that have no issue whatsoever with a woman picking up the check all the time, paying for their indulgences etc. They only feel the need to assert and affirm their man-ness to other people (and perhaps themselves!) when they are dealing with a woman who reads into their BS and refuses to indulge their nonsense! Bure kabisa!

Such thinking simply has no place siku hizi!

There are other pleasant things going on in my non-business life that I don’t want to blog about yet, but boy, am I glad to be back!

Happy goings everyone and do not let anything stand in the way of doing what it is you want to get done. The major thing begins with YOU taking the first step.

Be bold and have a great year!