Morgan Stanley 1999 Annual Report Download - page 77

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page 75 |99 AR
leases and finances these assets by issuance of non-recourse debt in
the securitization market and other similar financing arrangements.
The counterparties to the Company’s fixed income trans-
actions include investment advisors, commercial banks, insurance
companies, investment funds and industrial companies.
FOREIGN EXCHANGE
The Company is a market-maker in a number of foreign currencies.
In this business, it actively trades currencies in the spot and for-
ward markets earning a dealer spread. The Company seeks to man-
age its market risk by entering into offsetting positions. The
Company conducts an arbitrage business in which it seeks to prof-
it from inefficiencies between the futures, spot and forward mar-
kets. The Company also makes a market in foreign currency
options. This business largely is client-driven and involves the pur-
chasing and writing of European and American style options and
certain sophisticated products to meet specific client needs. The
Company profits in this business by earning spreads between the
options’ premiums and the cost of hedging such positions. The
Company limits its market risk by using a variety of hedging strate-
gies, including the buying and selling of the currencies underlying
the options based upon the options’ delta equivalent. Foreign
exchange option contracts give the purchaser of the contract the
right to buy (call) or sell (put) the currency underlying the contract
at an agreed-upon strike price at or over a specified period of time.
Forward contracts and futures represent commitments to purchase
or sell the underlying currencies at a specified future date at a
specified price. The Company also takes proprietary positions in
currencies to profit from market price and volatility movements in
the currencies positioned.
The majority of the Company’s foreign exchange business
relates to major foreign currencies such as yen, euro, pound ster-
ling, Swiss francs and Canadian dollars. The balance of the busi-
ness covers a broad range of other currencies.
The counterparties to the Company’s foreign exchange
transactions include commercial banks, investment banks, broker-
dealers, investment funds and industrial companies.
COMMODITIES
The Company, as a major participant in the world commodities mar-
kets, trades in physical precious, base and platinum group metals,
electricity, energy products (principally oil, refined oil products and
natural gas) as well as a variety of derivatives related to these com-
modities such as futures, forwards and exchange traded and OTC
options and swaps. Through these activities, the Company provides
clients with a ready market to satisfy end users’ current raw mate-
rial needs and facilitates their ability to hedge price fluctuations
related to future inventory needs. The former activity at times
requires the positioning of physical commodities. Derivatives on
those commodities, such as futures, forwards and options, often are
used to hedge price movements in the underlying physical inventory.
The Company profits as a market-maker in physical commodities by
earning the bid-offer spread inherent in the physical markets.
To facilitate hedging for its clients, the Company often is
required to take positions in the commodity markets in the form of
forward, option and swap contracts involving oil, natural gas, pre-
cious and base metals, and electricity. The Company generally
hedges these positions by using a variety of hedging techniques
such as delta hedging, whereby the Company takes positions in the
physical markets and/or positions in other commodity derivatives
such as futures and forwards to offset the market risk in the under-
lying derivative. The Company profits from this business by earning
a spread between the premiums paid or received for these deriva-
tives and the cost of hedging such derivatives.
The Company also maintains proprietary trading positions
in commodity derivatives, including futures, forwards and options
in addition to physical commodities, to profit from price and volatil-
ity movements in the underlying commodities markets.
Forward, option and swap contracts on commodities are
structured similarly to like-kind derivative contracts for cash finan-
cial instruments. The counterparties to OTC commodity contracts
include precious metals producers, refiners and consumers as well
as shippers, central banks, and oil, gas and electricity producers.
The following discussions of risk management, market
risk, credit risk, concentration risk and customer activities relate to
the Company’s trading activities.