CIA Annual Meeting LOOKING BACK…focused on the future

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future Moderator Jacques Boudreau Moderator Jacques Boudreau

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future Current status Why is CLIFR concerned? Some historical data Big Mac index Analysis Proposal Current status Why is CLIFR concerned? Some historical data Big Mac index Analysis Proposal

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future Standard : The needed assumptions would include foreign exchange rates when policy liabilities and their supported assets are denominated in different currencies. Standard : The needed assumptions would include foreign exchange rates when policy liabilities and their supported assets are denominated in different currencies.

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future Standard : The best estimate would be for continuance of the foreign exchange rates at the balance sheet date, except that the best estimate should anticipate any imminent unfavourable devaluation. There would be a provision for adverse deviation in respect of a currency mismatch. Standard : The best estimate would be for continuance of the foreign exchange rates at the balance sheet date, except that the best estimate should anticipate any imminent unfavourable devaluation. There would be a provision for adverse deviation in respect of a currency mismatch.

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future 2004 Fall Letter Encourages the development of an integrated multi-currency interest model Best estimate: Consider projected exchange rates and interest rate differentials. PfAD: Consideration given currency valuation, productivity levels, supply shortage, terrorism, wars Fall Letter Encourages the development of an integrated multi-currency interest model Best estimate: Consider projected exchange rates and interest rate differentials. PfAD: Consideration given currency valuation, productivity levels, supply shortage, terrorism, wars.

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future 'Too many inadequate reserves for naked positions'

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future Canada – US exchange rate January 1975 to December 2004 Highest: $ June 1976 Lowest: $ February 2002 Depreciation of 39.5% in 308 months. Canada – US exchange rate January 1975 to December 2004 Highest: $ June 1976 Lowest: $ February 2002 Depreciation of 39.5% in 308 months.

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future Canada – UK exchange rates January 1975 to December 2004 Highest: £ February 1985 Lowest: £ October 1980 Appreciation of 78.8% in 52 months. Canada – UK exchange rates January 1975 to December 2004 Highest: £ February 1985 Lowest: £ October 1980 Appreciation of 78.8% in 52 months.

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future Canada – EURO exchange rates January 1989 to December 2004 Highest: € August 1989 Lowest: € March 1995 Depreciation of 39.2% in 67 months. Canada – EURO exchange rates January 1989 to December 2004 Highest: € August 1989 Lowest: € March 1995 Depreciation of 39.2% in 67 months.

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future Canada – Jamaica exchange rates January 1991 to December 2004 Highest: $ November 2004 Lowest: $ January 1991 Appreciation of 639.6% in 166 months. Canada – Jamaica exchange rates January 1991 to December 2004 Highest: $ November 2004 Lowest: $ January 1991 Appreciation of 639.6% in 166 months.

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future The Economist’s BIG MAC Index Invented in 1986 Light-hearted guide to the “correctness” of currency levels Based on purchasing-power parities (PPP) The Economist’s BIG MAC Index Invented in 1986 Light-hearted guide to the “correctness” of currency levels Based on purchasing-power parities (PPP)

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future Theory of PPP says that in the long run exchange rates should move towards rates that would equalize the prices of an identical basket of goods and services in any two countries.

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future How it works: Japanese Big Mac yens American Big Mac 2.90 U.S. dollars PPP Exchange The Yen is 20% undervalued How it works: Japanese Big Mac yens American Big Mac 2.90 U.S. dollars PPP Exchange The Yen is 20% undervalued

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future As of June 9 th, 2005 Undervalued currencies Vs. the U.S. dollar Percentage Canada -14 Australia -18 Argentina -46 Brazil -22 China -59 Russia -52 As of June 9 th, 2005 Undervalued currencies Vs. the U.S. dollar Percentage Canada -14 Australia -18 Argentina -46 Brazil -22 China -59 Russia -52

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future As of June 9 th, 2005 Overvalued currencies Vs. the U.S. dollar Percentage Kuwait 142 Iceland 118 Norway 98 Switzerland 65 Sweden 36 As of June 9 th, 2005 Overvalued currencies Vs. the U.S. dollar Percentage Kuwait 142 Iceland 118 Norway 98 Switzerland 65 Sweden 36

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future Best Estimate Currency forwards If not available, determined based on interest rate differentials. Best Estimate Currency forwards If not available, determined based on interest rate differentials.

CIA Annual Meeting Session 5404: Measuring and Managing Currency Risks LOOKING BACK…focused on the future MfAD 5% to 50% drop in value Low margin: Short term, highly integrated economies High margin: Longer term, developing economies Test for worst time of drop, similar to what is done for equities. MfAD 5% to 50% drop in value Low margin: Short term, highly integrated economies High margin: Longer term, developing economies Test for worst time of drop, similar to what is done for equities.