Foreign Exchange

-Risk & Exposure


2 . ‡ There are many risks associated which will be covered in the presentation.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 degree of risk is very high ‡ The bank makes loses in hope for making super and instant profits. ‡ The large portion of a banks bottom line comes from its treasury operation.

but the dealer cannot control all time. political instabilities etc ‡ FX rates are affected by illogical sentiments ‡ FX market is operated 24 Hrs. ‡ Credit rating can affect the exchange rates 3 . regulations.Causes of fluctuation in FX ‡ Influenced by international factors ‡ Rates move as per government policies.

Types of FX Risk??? ‡ ‡ ‡ ‡ ‡ ‡ ‡ Transaction risk Position risk Settlement/Credit risk Liquidity risk Operational risk Sovereign risk Cross country risk 4 .

5 .Customer either cancels the transaction or doesn¶t honor the transaction.‡ Transaction risk. ‡ Settlement risk. ‡ Mismatch risk. ‡ Position risk.Transaction leading to future receipts in any form or creation of long term assets.A banker gets customer on either on bid or ask side. So the bank is yet to square off his position.There is mismatch between settlement date and the trade date.

‡ Sovereign risk.Excessive holding of one particular foreign currency.The government of the country is not willing to honor the transaction because of political instability ‡ Operational risk. improper tracking of transaction or technical flaw. ‡ Cross country risk. 6 .Deal agreed orally but not confirmed and not recognized by the main server of the bank.

fiscal policies.In a nut. ‡ Transaction risk arises from ordinary« ‡ FX rates vary because of government regulations. export and investment decision. 7 . etc. ‡ Settlement risk are of two types pre & post settlement. ‡ Position risk is because of net short or net long position of the banker. sentiments.

8 .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.e. ‡ Sovereign risk is the risk taken on the government i. ‡ Cross country is the excessive exposure on a particular country. country.

Exposure arises because of the transaction with foreign entities. As long as one is not transacting in the foreign market. ‡ These exposures can be covered through forward contracts.FX -Exposure ‡ Risk always exists in the forex market. futures or options 9 . he is not exposed to such risks.

Exposure due to trade (Current account) transaction.Types of exposure ‡ Exposures may be broadly categorized into 3 broad categories:‡ Transaction exposure:. 10 . Main factor is volatility of foreign exchange rates.

It is an exposure in the capital account.‡ Economic exposure. this exposure is noticed. FDI.It is an accounting exposure. ‡ Translation exposure. It¶s a notional exposure 11 .exposure due to setting up a factory or such long term investment. While MNCs consolidate their balance sheets.

thus it is a contingent exposure 12 . thus the rates can change at that time.Other types of F-Exposures« ‡ Contingent exposure. ‡ For eg. but the approval may take approx 6 months.At the time of tender submission a company may quote the present FX rates.This arises out of possible future forex flows whose exchange rate cannot be fixed now.

Competitive exposure is not about direct first level cash flow effect. But if China trains its manpower for English.It is a combination of transaction exposure and economic exposure. Manufacturing units are mostly vulnerable to competitive exposure.‡ Competitive exposure. ‡ For eg-Indian BPO market is booming because of cost advantage. then Indian BPOs will get thinner profit margin 13 .

Strategies to avoid Risk and Exposure ‡ Hedging-It is a transaction undertaken specifically to offset some exposure arising out of the firms usual operation.Deliberate creation of a position for the express purpose of generating a profit from exchange rate fluctuations. ‡ Speculation. accepting added risk 14 .

‡ Futures-Futures are exchanged traded contracts to sell or buy financial instruments or physical commodities for future delivery at an agreed price. ‡ Currency swaps-In a currency swap.It gives the buyer the right but not obligation to exercise the option at the maturity. 15 . the two payment streams being exchanged are denominated in two different currencies.‡ Call and put options.

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