Foreign Exchange

-Risk & Exposure

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 Introduction
• Foreign Exchange business has become Very
important these days not only for companies and
banks but also from country’s point of view.
• The large portion of a banks bottom line comes from
its treasury operation.
• The degree of risk is very high
• The bank makes loses in hope for making super and
instant profits.
• There are many risks associated which will be
covered in the presentation.

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 Causes of fluctuation in
FX
• Influenced by international factors
• Rates move as per government policies, regulations,
political instabilities etc
• FX rates are affected by illogical sentiments
• FX market is operated 24 Hrs, but the dealer cannot
control all time.
• Credit rating can affect the exchange rates

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 Types of FX Risk???
• Transaction risk
• Position risk
• Settlement/Credit risk
• Liquidity risk
• Operational risk
• Sovereign risk
• Cross country risk

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• Transaction risk- Transaction leading to future
receipts in any form or creation of long term assets.
• Position risk- A banker gets customer on either
on bid or ask side. So the bank is yet to square off his
position.
• Mismatch risk- There is mismatch between
settlement date and the trade date.
• Settlement risk- Customer either cancels the
transaction or doesn’t honor the transaction.

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• Sovereign risk- The government of the country is
not willing to honor the transaction because of
political instability
• Operational risk- Deal agreed orally but not
confirmed and not recognized by the main server of
the bank, improper tracking of transaction or
technical flaw.
• Cross country risk- Excessive holding of one
particular foreign currency.

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 In a nut- shell…
• FX rates vary because of government regulations,
fiscal policies, sentiments, etc.
• Transaction risk arises from ordinary trading, export
and investment decision.
• Position risk is because of net short or net long
position of the banker.
• Settlement risk are of two types pre & post
settlement.

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Contd…
• Mismatch risk arises because it is rarely possible to
cover the risk perfectly on the time value scales and
also match the variations for the two.
• Operational risk are the risk are related to the manner
in which the transaction are settled.
• Sovereign risk is the risk taken on the government
i.e. country.
• Cross country is the excessive exposure on a
particular country.

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 FX
-Exposure
• Risk always exists in the forex market.
As long as one is not transacting in the
foreign market, he is not exposed to
such risks. Exposure arises because of
the transaction with foreign entities.
• These exposures can be covered
through forward contracts, futures or
options

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 Types of exposure
• Exposures may be broadly categorized
into 3 broad categories:-

• Transaction exposure:- Exposure due to

trade (Current account) transaction. Main
factor is volatility of foreign exchange rates.

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• Economic exposure- exposure due to
setting up a factory or such long term
investment, FDI. It is an exposure in the
capital account.
• Translation exposure- It is an accounting
exposure. While MNCs consolidate their
balance sheets, this exposure is noticed. It’s
a notional exposure

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Other types of F-Exposures…
• Contingent exposure- This arises out of
possible future forex flows whose exchange
rate cannot be fixed now.
• For eg- At the time of tender submission a
company may quote the present FX rates, but
the approval may take approx 6 months, thus
the rates can change at that time, thus it is a
contingent exposure

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• Competitive exposure- It is a
combination of transaction exposure and
economic exposure. Competitive exposure is
not about direct first level cash flow effect.
Manufacturing units are mostly vulnerable to
competitive exposure.
• For eg-Indian BPO market is booming
because of cost advantage. But if China
trains its manpower for English, then Indian
BPOs will get thinner profit margin

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 Strategies to avoid Risk and
Exposure
• Hedging-It is a transaction undertaken
specifically to offset some exposure arising
out of the firms usual operation.

• Speculation- Deliberate creation of a

position for the express purpose of
generating a profit from exchange rate
fluctuations, accepting added risk

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• Call and put options- It gives the buyer
the right but not obligation to exercise the
option at the maturity.
• Currency swaps-In a currency swap, the
two payment streams being exchanged are
denominated in two different currencies.
• Futures-Futures are exchanged traded
contracts to sell or buy financial instruments
or physical commodities for future delivery at
an agreed price.

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 THANK YOU
17-Jayesh Goradia
36- Mrugesh Pathak
41- Shamindra Randive
56-Nimish Thakker
60 Akhilesh Yadav

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