Front Matter Page
Monetary and Exchange Affairs Department
Authorized for distribution by Patricia Brenner
Contents
I. Introduction
II. Derivatives, Currency Holdings and Cross-Border Positions
A. Convertibility Option Embedded in Domestic Currency Holdings
B. Cross-Border Positions and Domestic Currency Holdings
III. Recent Evidence of Unstable Financial Inflows and Destabilizing Strategies Related to Derivatives
A. Financial Flows Instability
B. Destabilizing Strategies
Positive feedback
Cross hedging
C. Consequences of Compensatory Surcharges to the Cost of Capital
IV. Cross-Border Derivatives and Monetary Transmission
A. Derivatives and Monetary Transmission
B. Cross-Border Derivatives and Asset Substitutability
Conditions for enhanced asset substitutability
Financial development
Policy credibility
Adequate infrastructure
Central bank role
V. A Note on the Use of Derivatives by Monetary Authorities
A. Central Bank Derivatives to Promote Asset Substitutability
B. Central Bank Derivatives to Counteract Short-Term Positions
C. Exceptional Uses of Central Bank Derivatives
VI. Conclusions
References
Appendix: Basic Derivative Instruments
Figures
Figure 1. Merton’s Option-based Model for Valuing Debt and Equity
Figure 2. Put Option Embedded in Domestic Currency Holdings
Figure 3. Cross-Border Forward Positions
Figure 4. Alternative Scenarios
Figure 5. Destabilizing Strategies
Figure 6. Currency-Hedged Positions
Figure 7. Cross-Border Transactions Involving Derivatives
Figure 8. Barrier Options
Figure 9. Derivatives for Market Development
Figure 10. Central Bank Use of Derivatives