Inflation-Immunized Currency Futures
INFLATION-IMMUNIZED CURRENCY FUTURES
Real Return Methodologies
Inflation-immunized currency futures are, we believe, an ideal initial product in the area of real derivatives, including real futures, real options, and real swaps. The contracts can be used to launch a new exchange for real futures and real options.
A natural outgrowth of the market for real futures and options will be an automated
market for real securities – specifically the (patent protected) Real
Return Methodologies (RRM) securities developed by Task Management, Inc.
The inflation-immunized currency futures will specify a real, inflation-adjusted, amount
of one currency to be delivered at a future date in return for a real, inflation-adjusted, amount of
another currency. Price indices will be used to adjust purchasing power to a base period.
For example, a contract might be for £10,000 in January 1, 2000 UK pounds to be delivered on the
last business day of March, 2016, in return for the payment of $16,221 in January 1, 2000 US
Contracts can specify cash settlement or actual delivery.
International investors will use the contracts to decompose nominal currency risk into:
● Real currency risk; and,
● The risk of unknown future relative inflation rates.
The availability of contracts with a long-maturity (e.g., 10 years) will maximize the utility of this
new investment and risk management tool. Potential customers include but are not limited to:
● Hedge funds;
● Pension funds and other institutional investors;
● Central banks managing their currency reserves;
● Countries seeking international financing to fund growth and infrastructure; and,
● Multinational corporations seeking to manage currency risk and minimize
The ability to hedge the real component of currency risk with inflation-immunized
currency futures will encourage international investment in all assets that offer an inflation hedge,
● Common stock;
● Real estate;
● Government-issued Linkers; and especially,
● Real Return Methodologies (RRM) securities of all types.
As international demand for RRM securities grows, a natural next step will be an
automated market for international trading of RRM securities.
In conclusion, inflation-immunized currency futures (and other real financial products)
can create investment and risk management opportunities that are not available in a nominal-only
world. The exchanges that are created to trade these new, real products will have a bright future,
especially with the expanding patent-protection being put in place by TMI.
APPENDIX: MARKET PARTICIPANTS AND POTENTIAL APPLICATIONS
Hedge funds have become major participants in many markets, including derivatives
markets (e.g., 30% of all transactions in the credit derivatives market are now attributed to hedge
funds). Inflation-immunized futures will give hedge funds the ability to buy and sell constant purchasing power (real) currency risk.
This new market will give the funds the ability to hedge (or leverage) the real
currency risk that they take in their international investments. They can use the market to
continually adjust their hedges (sale of real currency risk) and/or speculations (purchase of real
currency risk) as market conditions and expectations change.
In addition, hedge funds will be able to use inflation-immunized currency futures to arbitrage the real returns of government issued Linkers by say going long TIPS, short inflation-linked gilts, and long inflation-immunized British pounds against inflation-immunized U.S. dollars.
In order to facilitate this arbitrage play, the price indices used to create the inflation-immunized currency futures can be based on the same price indices used to adjust the respective Linkers.
Pension funds are in need of long-term, real investments to fund their long-term, real
Inflation-immunized currency futures will increase their international investment
Suppose that a British pension fund is considering an investment in Canadian
Linkers. They will be able to hedge their real currency risk by shorting inflation-immunized
Canadian dollars against inflation-immunized British pounds.
By adjusting their hedge positions in response to changes in real currency exchange rates and market conditions, they will be able to increase their real returns while reducing their risk.
Central banks (such as the Chinese central bank) that hold large amount of U.S. dollars
will be able to use the market to reduce their exposure to a fall in the value of the U.S. dollar
without triggering a decline in the dollar through sales of U.S. securities.
By using the market to short inflation-immunized dollars against inflation-immunized Euros, inflation-immunized yen and/or other inflation-immunized currencies, they can protect against the real currency risk of their dollar holdings.
Then, by reallocating their holdings of U.S. Treasuries into securities that
offer inflation protection (e.g., TIPS, RRM securities denominated in U.S. dollars,
shorter-term nominal Treasuries whose rates are likely to rise with inflation, etc.), they can
manage the remaining component of their currency risk – the inflation component.
The market will offer speculators a whole new way to play the currency markets – a way
that strips out the inflation component leaving only the real currency risk.
By offering the ability to strip out the wild card of unknown future inflation risk, the market will, we believe, make currencies an even more attractive market for speculators.
Countries seeking international financing to fund growth and infrastructure (especially
developing countries with sound economic policies and stable governments) will benefit greatly
from the ability to manage real exchange rate risk with inflation-immunized currency futures.
For example, they can minimize default risk by using RRM™ securities (denominated in their
domestic currencies) to match debt service (the fixed real payments of the fully-amortizing
securities) to the expected real income of the projects being financed.
The inflation protection of the RRM securities eliminates the inflation risk component of the long-term currency risk and the international investors can use the inflation-immunized currency futures to hedge their real currency risk. Or, alternatively, the borrowing countries may issue RRM securities denominated in one of the reserve currencies of the world (e.g., U.S. dollars, Euros, Japanese yen, etc.), again matching real debt service to expected real income in order to minimize default risk, thus achieving a lower borrowing cost, and use inflation-immunized futures to hedge away their real exchange rate risk.
Multinational corporations seeking to minimize financing costs and manage currency risk
can issue RRM securities in whichever currencies offer the lowest fully-hedged borrowing
costs (U.S. dollars, Euros, Japanese yen, British pounds, etc.) and then use inflation-immunized
currency futures to hedge the real currency risk that results from their operations and/or asset
holdings in various countries. Note that TMI has a computer model that demonstrates the ability
of RRM financing to create value for corporate issuers and the persistence – or even increase
– of the value gain in the face of unanticipated increases in inflation following the issuance.
For example, a U.S. multinational with operations and assets in Mexico might finance its Mexican
operations by issuing RRM securities denominated in U.S. dollars, thus minimizing its
financing costs, and then go long inflation-immunized Mexican pesos and short
inflation-immunized U.S. dollars in order to hedge the real currency risk created by its Mexican
operations and asset holdings.