The Wall Street Journal reports,"the Chinese yuan fell to its lowest level in 10 months Monday after the country allowed its currency to trade more freely, hitting levels that sparked rapidly accumulating losses for investors who made billions of dollars in leveraged bets that the currency would keep appreciating".
The currency fell 0.5% to 6.1781 per dollar Monday, one of its biggest slides in a decade and on the first day of trading where it is allowed to trade in a 2% range. Losses on the offshore yuan accelerated as it hit a 10-month low of 6.1688 against the U.S. dollar, with a higher number meaning a lower yuan. The People's Bank of China, the country's central bank, widened the trading band from 1% a day on Saturday.
The sudden move lower is heightening concern over financial derivative products turning sour. Traders and analysts say banks are asking clients that have taken out such trades to boost their collateral and are getting inquiries from companies' about restructuring these leveraged bets.
The value of these derivative products come from complex calculations using the current exchange rate, volatility and time remaining on the options contracts. The bets were based on the assumption the yuan would stay on its steady path upward after rising 2.9% last year. But the yuan has dropped 2% this year, accompanied by wider price swings, meaning the contracts are worth less and for some are turning into losses.
Geoff Kendrick, head of Asian currencies and rates at Morgan Stanley estimates the current outstanding notional value-the total value of a leveraged position's assets-of one particular popular bet called the target redemption-forward products are at approximately $150 billion.
He says companies poured into these contracts between December and February when after the yuan had appreciated strongly. Now he estimates that owners of the contracts, many of which run for 24-months, are facing total mark-to-market losses of approximately $2.3 billion. If the currency was to weaken the maximum amount allowed in the daily 2% trading band, then losses would more than double to $5.5 billion.
