Question

government's responsibility to businesses in the case of kiko south korean won

Answer 1

Just few year before 2008, few local banks in South Korea sold KIKOs (knock-in knock-out currency derivatives) to small and medium-sized local exporters that wished to hedge risks that may be caused by currency volatility. As per these agreements, once the currency surpasses the ceiling value, the company should sell twice the predecided notional amount to the bank at the prevailing exchange rate, absorbing the exchange loss in the process. Similarily, if and when the currency dips below the lower limit, the contract would be terminated. These are conditions for validity of a KIKO contract. The contract thus expects the currency to move in a particular band.

But in 2008, once the global financial crisis began, the world economy started crumbling and the Korean won, along with other currencies plunged. This caused heavy losses to all market participants especially to the contacting companies in KIKO. Ideally, derivatives as a financial market instrument should be used only by those participants who are aware and can assess the risks inherent in the product. Thus Government should ideally have no responsibility for the losses incurred by participants who could not envisage this possibility of loss in derivatives market. Government however should be able to protect the smaller and more vulnerable small players who could have been played by/fooled by the bigger players. Thus the Government responsibility first begins with educating all the market participants about the risks inherent in such products. Government should ensure all agreements executed with sufficient disclosures. Government may also need to protect the needy players to avoid a systemic failure at such times like financial crisis.