Foreign Exchange Risk Management Org

TABLE OF CONTENT
• INTRODUCTION
• Meaning of Foreign Exchange
• Forex Management
• Risk Management
• OBJECTIVES
• RSEARCH METHODOLOGY.
• ANALYSIS
• FINDINGS.
• CONCLUSIONS.
• LIMITATIONS.
• BIBLIOGRAPHY.
ACKNOWLEDGEMENT
ACKNOWLEDGMENT
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Gratitude’s is the hardest of emotion to express and often does not find adequate
words to convey. Therefore a research report is not an effort of a single person
but it is a contribution effort of many hands and brains So, I would like to
thanks all those who have helped me directly during my research report .
With an ineffable sense of gratitude’s I take this opportunity to express my deep

sense of in debtness to Prof.P.N.Jha (Director of SMS) for allowing me to carry
out this research work.
I am also thankful to my mentor Dr. Gyanendra B.S.Johri Sir for his keen
interest construction criticism persistent encouragement and untiring thought
out the development of the report.
It has been my great privilege to work under his inspiring and provoking
guidance .
I would like to thank all my teachers specially coordinators Mr.Wamique Hisam

sir staff members and library member for their valuable advice and guiding
which help me to make this report more effective interesting and purpose full.
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DECLARATION
DECLARATION
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I hereby declare that the information
presented here is correct to the best of
my knowledge.
Place-
D ate-
Signature-
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PREFACE
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PREFACE
This survey report had been conducted

FOREIGN EXCHANGE AND RISK
MANAGEMENT. The purpose of this report
and preparation of this report is to find
out the performance of Foreign exchange
sector.
This report is carried out to in the partial
fulfillment of the BBA 6th semester course
of “SCHOOL OF MANAGEMENT OF
SCIENCES” VARANASI
INTRODUCTION
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An Introduction to Foreign Exchange
The term “foreign exchange” basically refers to buying the currency of one
country while selling the currency of another country. All nations have their
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own, different kinds of money (currency). This has existed throughout the ages,
probably since the time of the Babylonians. As trading developed between
nations, the need to convert one kind of money to another also developed. This is
how a formal system of foreign exchange arose. As trade between nations
developed, Britain, as the nation with the largest and strongest navy, could spread
its commercial interests far and wide. It therefore became the most active trading
nation, with a vast empire of colonies. As a result, Britain’s currency, the pound
sterling, became a benchmark to which other currencies were compared (and
exchanged) for most of the seventeenth, eighteenth and nineteenth centuries.
Today, most currencies are compared to the U.S. Dollar, currently the most active
and commercially strong trading nation; many currencies are still “pegged” to the
U.S. Dollar for their exchange rate.
Currencies traded
A company that wants to import goods into the United States has to buy the foreign
currency of the country the goods are coming from, in order to pay for them. The
following is an example: an American shoe store may sell a lot of Brazilian shoes,
since Brazil is a large exporter of leather goods (about $1.9 Billion per year). The
owner of this store would have to buy Brazilian Reals (the currency of Brazil) to
pay for a shipment of shoes. He has a number of choices. First, he could buy the
Reals through his bank or a foreign exchange broker at fixed rate of exchange, and
then order the shoes. Since he knows the exchange rate, he knows how much the
shoes are worth in dollars, and how much his bill (in dollars) will be when he has
to pay for the shipment of shoes. When he “takes delivery” of the Reals (that is, he
tells his bank to pay the Brazilian exporter), his bank will debit him the U.S. Dollar
equivalent at the rate agreed upon when he purchased the Reals.
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This importer has the second option of waiting until the shoes arrive in the United
States, and then buy the Reals to pay for them. He will not know how much he has
to pay for this shipment of shoes until he pays for the Reals, rather when he entered
into the contract to purchase the shoes. If the Real got stronger, in other words,
became more expensive compared to the dollar, he would pay more for them in
dollars than on the day of his contract. He could also pay less if the Real became
weaker. But most businessmen want to protect themselves and the price of their
products against higher costs and be able to manage their budgets.
Knowing the exchange rate of the real when he processed his order with the
Brazilian exporter would allow him include that rate into his selling costs. If he
risks that the rate will come down (by not buying Reals ahead of time), and it goes
up instead, he may end up with a loss in the price of his shoes. Most businessmen
would rather leave this kind of “speculating” to foreign exchange traders!
The Basics of the Foreign Exchange Market

At the completion of this lesson, you should understand:
• The characteristics of foreign exchange and how it differs from other

financial markets.
• The driving forces behind today's foreign exchange market activity.
• How the advent of online foreign exchange trading on margin has benefited
the individual trader.
Meaning of forex exchange.
A sophisticated individual who trades with significant leverage, taking on above

average risk in hopes of above average returns.
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Foreign exchange consists of trading one type of currency for another. Unlike other
financial markets, the FX market has no physical location and no central exchange.
It operates "over the counter" through a global network of banks, corporations and
individuals trading one currency for another. The FX market is the world's largest
financial market, operating 24 hours a day with enormous amounts of money
traded on a daily basis.
Unlike any other financial market, investors can respond to currency fluctuations
caused by economic, political and social events at the time they occur, without
having to wait for exchanges to open. Access to modern news services, charting
services, 24- hour dealing desks and sophisticated online electronic trading
platforms has seen speculation in the FX market explode, particularly for the
individual trader.
The currency markets are not new. They've been around for as long as banks have
been doing business. What is relatively new is the accessibility of these markets to
the individual speculator, particularly the small- to medium-sized trader.
A Short History of the Foreign Exchange Trading

Market
Arbitrage
The simultaneous sale (or purchase) of a financial instrument and the taking of an
equal and opposite position in a similar instrument to provide a profit. That is,
exploiting pricing differences (anomalies) across markets. True arbitrage is risk
free.
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Exchange Rate
The rate at which one currency is traded against another.
Margin in the context of FX & CFDs

A cash deposit provided by clients as collateral to cover losses (if any) that may
result from the client's trading activities.
"Pegged" Currency
A currency is pegged or fixed when its country's Central Bank decides to tie its
value to a stronger currency, in an effort to stabilize its own currency. Currencies
such as the Hong Kong Dollar have historically pegged to the US Dollar.
The Arithmetic Of Exchange

A further factor, and one of considerable importance in its effects upon trade
balances, at least as far as this country is concerned, is the personal expenditure of
travelers abroad. It is roughly estimated that this amounts to something like
$150,000,000 per annum. In order to meet the needs of this class, a peculiar
instrument has been called into being - the Letter of Credit, which is addressed to a
certain number of banking firms, and sets forth that N. M. is the bearer, and is
entitled to draw upon a certain bank, generally located in London, for a specified
amount. Payments as made in different localities, are indorsed on the Letter of
Credit itself, and when exhausted it is returned with the last draft. A modification
of this instrument is found in the Circular Note, or Travelers' Check, which calls
for a specific amount in U. S. Dollars, and is payable in various countries at certain
fixed rates. A further important instrument in connection with the Foreign
Exchange business, is the Commercial Letter of Credit, used principally by
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importers. This is usually addressed to a firm by a bank or banker, authorizing
them to value on its correspondent for a fixed amount, and engages that the drafts
drawn thereunder will be protected if drawn in accordance with the terms of the
Letter of Credit. The terms are, as a rule, that the draft should be accompanied by
Bills of Lading, Consular Invoices and Insurance Certificates, showing the
shipment of goods purchased. The most common instruments used in foreign
transactions are checks or cheques, demand drafts and time drafts. Checks are most
commonly used for payments on demand. Most countries have legislated in favor
of this method of transferring funds by means of the entire abolition, or
modification, of the stamp tax - hence demand drafts are very seldom used. In
continental countries the circulation of a check is limited as to time, particularly in
France, and in order to avoid the possibility of a change in date the law in that
country requires that all checks be dated in words, thus - August fourteenth, 1903 -
instead of Aug. 14, 1903; and in Germany a check must expressly state that the
funds transferred are derived from a balance due the maker. A peculiar method in
vogue of evading the stamp tax in Germany when it is not possible to make the
required declaration as to funds due, is to issue what is called a delegation-i. e., a
communication addressed to the beneficiary that a specified sum will be held at his
(the beneficiary's) disposal upon his application to certain designated parties. This
instrument is not intended for circulation, as its very nature deprives it of that
characteristic. Demand drafts have been almost entirely displaced by checks and
delegations, hence are very rarely used. They are subject to a tax of 1/2% per mille,
(1/2°/oo) in most all European countries, the same as time drafts.
Time drafts on merchants, with shipping documents attached, enable the purchaser
to dispose of the goods by sale before paying for same, and generally contain a
provision where the documents are held as security for the payment of the draft
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that in the event of the drawee desiring to withdraw the merchandise, he can do so
upon payment of the draft, less a rebate of interest at the official bank rate for the
unexpired time. This on the Continent. In England such a draft may be paid prior to
maturity under a rebate of interest of 1/2% above the advertised rate for it must be
noted that the quotations for French exchange progress by § of 1%, and as the
quotations are for so many Francs and Centimes per dollar, each progression would
be the equivalent of 1/8 of 1% in our money, and when it is desired to shade the
rate either up or down, this is done by quoting the rate plus 1-16%, plus 1-32%, or
minus 1-16 or 1-32. It must be further noted that as the foreign denomination in
this case is the variable quantity, the higher the quotation the lower the rate of
exchange.
Taking the sight draft as a basis, the following calculations will demonstrate how
the quotations for telegraphic transfers and 60 d/s bills are arrived at; e. g.
quotation for sight drafts on England, 485 1/4. Sight drafts or checks have an
average circular short deposits in the London Joint Stock Banks, which as a rule is
1 1/2% below the Bank of England rate. Thus should the Bank of England rate be
3%, the rebate rate would be 2%.
Sterling. Tel. Transfers. Sight. 60 days.

Posted rates ..... ........... 487 1/2 484
Actual ......... 485 5/8 485 1/4 482 5/8
Commercial .... 485.40 485 483
Germany.
Actual ......... 95 11-32 95 1/4 94 ¾
Commercial .... ...... 3 days 95 1/8 94 ½
France.
Actual........ 517 1/2 - 1-32 518 1/8 520 5/8 + l - 16
Commercial.... ...... 3 days 519 3/8 521 1/4
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The regular quotations of foreign exchange cover three distinct classes:
1. Posted rates. These are rates arbitrarily determined by international bankers in

New York for the purpose of adjusting foreign currencies payable in the United
States, and are generally somewhat higher than the actual rates.
2. Actual rates, are the rates at which bankers will sell their own drafts,
telegraphic transfers, etc.
3. Commercial rates, are the buying rates of bills of exchange, etc., issued by
merchants in the regular course of business
Foreign Exchange Management Act

The Foreign Exchange Regulation Act of 1973 (FERA) in India was repealed on 1
June, 2000. It was replaced by the Foreign Exchange Management Act (FEMA),
which was passed in the winter session of Parliament in 1999. Enacted in 1973, in
the backdrop of acute shortage of Foreign Exchange in the country, FERA had a
controversial 27 year stint during which many bosses of the Indian Corporate
world found themselves at the mercy of the Enforcement Directorate (E.D.). Any
offense under FERA was a criminal offense liable to imprisonment, whereas
FEMA seeks to make offenses relating to foreign exchange civil offenses.
FEMA, which has replaced FERA, had become the need of the hour since FERA
had become incompatible with the pro-liberalisation policies of the Government of
India. FEMA has brought a new management regime of Foreign Exchange
consistent with the emerging frame work of the World Trade Organisation (WTO).
It is another matter that enactment of FEMA also brought with it Prevention of
Money Laundering Act, 2002 which came into effect recently from 1 July, 2005
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and the heat of which is yet to be felt as “Enforcement Directorate” would be
invesitigating the cases under PMLA too.
Unlike other laws where everything is permitted unless specifically prohibited,

under FERA nothing was permitted unless specifically permitted. Hence the tenor
and tone of the Act was very drastic. It provided for imprisonment of even a very
minor offence. Under FERA, a person was presumed guilty unless he proved
himself innocent whereas under other laws, a person is presumed innocent unless
he is proven guilty.
Foreign-Exchange Risk
Meaning of Foreign-Exchange Risk

1. The risk of an investment's value changing due to changes in currency exchange
rates.
2. The risk that an investor will have to close out a long or short position
in a foreign currency at a loss due to an adverse movement in exchange rates. Also
known as "currency risk" or "exchange-rate risk".
Foreign-Exchange Risk
This risk usually affects businesses that export and/or import, but it can also affect
investors making international investments. For example, if money must be
converted to another currency to make a certain investment, then any changes in
the currency exchange rate will cause that investment's value to either decrease or
increase when the investment is sold and converted back into the original currency.
International Operation
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Foreign Exchange Management Since 1986
The Second-tier Foreign Exchange Market (SFEM) came into being on September
26, 1986 when the determination of the Naira exchange rate was made to reflect
market forces. The modalities for the management of the Foreign Exchange
Market have changed substantially since the introduction of SFEM, in line with the
principles of the Structural Adjustment Programme (SAP) which emphasise the
market-oriented approach to price determination.
Within the basic framework of market determination of the Naira exchange rate,
various methods were applied and some adjustments carried out to fine-tune the
system. A transitory dual exchange rate system (first and second-tier) was adopted
in September, 1986. On 2nd July 1987, the first and second-tier markets were
merged into an enlarged Foreign Exchange Market (FEM). Various pricing
methods, such as marginal, weighted average and Dutch system, were adopted.
With the introduction of the SFEM, the Federal Ministry of Finance had its
allocative powers transferred to the CBN, but it retained approving powers on
public sector transactions.
The constant fine-tuning of the market culminated in the complete floating of the
naira on March 5, 1992 when the system of pre-determined quotas was
discontinued. The unabating pressure on the foreign exchange market resulted in
the policy reversal in 1994. The reversal of policy in 1995 to that of "guided
deregulation" necessitated the institution of the Autonomous Foreign Exchange
Market (AFEM). Apart from the institution of an appropriate mechanism for
exchange rate determination, other measures increasingly applied in managing
Nigeria's foreign exchange resources included demand management and supply
side policies. The CBN and the government have actively fostered the
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development of institutions such as the Nigerian Export Promotion Council
(NEPC) and the Nigerian Export-Import Bank (NEXIM) in the drive to earn more
foreign exchange.
The AFEM metamorphosed into a daily, two-way quote Inter-Bank Foreign

Exchange Market (IFEM) on October 25, 1999. The IFEM is expected to broaden
and deepen the foreign exchange market on daily basis and discourage speculative
activities.
Exchange Rate Movement

The average AFEM intervention rate which closed at 82.33 to a dollar in 1995
appreciated to 81.48 per dollar in 1996. The rate depreciated continuously to 81.98,
84.84 and 91.83 in 1997, 1998 and 1999 respectively. The rates in the bureaux de
change showed similar trend. At the bureaux de change, the rate closed at 83.69 to
a dollar in 1995, appreciated to 83.15 per dollar in 1996 before depreciating
continuously to 99.26 per dollar in 1999. The parallel market premium moved
from 1.6 per cent in 1996 to 3.2 per cent in 1999. Meanwhile, the market
determined exchange rate at the IFEM has remained within the pre-determined
fluctuation bands.
Exchange rate risk

Exchange rate risk is simply the risk to which investors are exposed because
changes in exchange rates may have an effect on investments that they have made.
The most obvious exchange rate risks are those that result from buying foreign
currency denominated investments. The commonest of these are shares listed in
another country or foreign currency bonds.
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Investors in companies that have operations in another country, or that export, are
also exposed to exchange rate risk. A company with operations abroad will find the
value in domestic currency of its overseas profits changes with exchange rates.
Similarly an exporter is likely to find that an appreciation in its domestic currency

will mean that either sales fall (because its prices rise in terms of its customers
currency) or that its gross margin shrinks, or both. A depreciation of its domestic
currency would have the opposite effect.
However the two risks can often hedge each other. Suppose an investor in the US
buys shares in a British company. There will be a risk that the value of the
investment in dollar terms may decline if the pound falls against the dollar.
Now suppose that the British company makes a substantial proportion of its sales
in the US and most of the rest of its sales are dollar denominated exports. This
situation is not uncommon in sectors like pharmaceuticals or IT, or any which sell
into truly global product markets.
In these circumstances a fall in the value of sterling is likely to reduce the value of
the shares of the British company in dollar terms, for a given share price in sterling
terms. However if the pound depreciates, the share price is likely to rise as the
value in pounds of its dollar denominated sales rises.
The end result is that the two types of exchange rate risk neatly hedge each other.
succeed domestic demand (at reasonable prices), must depend on exporting them.
FOREX, an acronym for Foreign Exchange, is the largest financial market in the
world. With an estimated $1.5 trillion in currencies traded daily, Forex provides
income to millions of traders and large banks worldwide. The market is so large in
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volume that it would take the New York Stock Exchange, with a daily average of
under $20 billion, almost three months to reach the amount traded in one day on
the Foreign Exchange Market.
Forex, unlike other financial markets, is not tied to an actual stock exchange. Forex
is an over-the-counter (OTC) or off-exchange market.
Background
Historically, Forex has been dominated by inter-world investment and commercial

banks, money portfolio managers, money brokers, large corporations, and very few
private traders. Lately this trend has changed. With the advances in internet
technology, plus the industry's unique leveraging options, more and more
individual traders are getting involved in the market for the purposes of
speculation. While other reasons for participating in the market include facilitating
commercial transactions (whether it is an international corporation converting its
profits, or hedging against future price drops), speculation for profit has become
the most popular motive for Forex trading for both big and small participants.
The Functions of the Foreign Exchange Market
1. The foreign exchange market serves two functions: converting currencies and
reducing risk. There are four major reasons firms need to convert currencies.
2. First, the payments firms receive from exports, foreign investments, foreign
profits, or licensing agreements may all be in a foreign currency. In order to use
these funds in its home country, an international firm has to convert funds from
foreign to domestic currencies.
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3. Second, a firm may purchase supplies from firms in foreign countries, and pay
these suppliers in their domestic currency.
4. Third, a firm may want to invest in a different country from that in which it
currently holds underused funds.
5. Fourth, a firm may want to speculate on exchange rate movements, and earn
profits on the changes it expects. If it expects a foreign currency to appreciate
relative to its domestic currency, it will convert its domestic funds into the foreign
currency. Alternately stated, it expects its domestic currency to depreciate relative
to the foreign currency. An example similar to the one in the book can help
illustrate how money can be made on exchange rate speculation. The management
focus on George Soros shows how one fund has benefited from currency
speculation.
6. Exchange rates change on a daily basis. The price at any given time is called the
spot rate, and is the rate for currency exchanges at that particular time. One can
obtain the current exchange rates from a newspaper or online.
7. The fact that exchange rates can change on a daily basis depending upon the
relative supply and demand for different currencies increases the risks for firms
entering into contracts where they must be paid or pay in a foreign currency at
some time in the future.
8. Forward exchange rates allow a firm to lock in a future exchange rate for the
time when it needs to convert currencies. Forward exchange occurs when two
parties agree to exchange currency and execute a deal at some specific date in the
future. The book presents an example of a laptop computer purchase where using
the forward market helps assure the firm that will won't lose money on what it feels
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is a good deal. It can be good to point out that from a firm's perspective, while it
can set prices and agree to pay certain costs, and can reasonably plan to earn a
profit; it has virtually no control over the exchange rate. When spot exchange rate
changes entirely wipe out the profits on what appear to be profitable deals, the firm
has no recourse.
9. When a currency is worth less with the forward rate than it is with the spot rate,
it is selling at forward discount. Likewise, when a currency is worth more in the
future than it is on the spot market, it is said to be selling at a forward premium,
and is hence expected to appreciate. These points can be illustrated with several of
the currencies.
10. A currency swap is the simultaneous purchase and sale of a given amount of
currency at two different dates and values.
Meaning of risk management

Risk management ensures that an organization identifies and understands the risks
to which it is exposed. Risk management also guarantees that the organization
creates and implements an effective plan to prevent losses or reduce the impact if a
loss occurs.
A risk management plan includes strategies and techniques for recognizing and
confronting these threats. Good risk management doesn’t have to be expensive or
time consuming; it may be as uncomplicated as answering these three questions:
Benefits from managing risk

Risk management provides a clear and structured approach to identifying risks.
Having a clear understanding of all risks allows an organization to measure and
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prioritize them and take the appropriate actions to reduce losses. Risk management
has other benefits for an organization, including:
• Saving resources: Time, assets, income, property and people are all valuable
resources that can be saved if fewer claims occur.
• Protecting the reputation and public image of the organization.
• Preventing or reducing legal liability and increasing the stability of
operations.
• Protecting people from harm.
• Protecting the environment.
• Enhancing the ability to prepare for various circumstances.
• Reducing liabilities.
• Assisting in clearly defining insurance needs.
An effective risk management practice does not eliminate risks. However, having
an effective and operational risk management practice shows an insurer that your
organization is committed to loss reduction or prevention. It makes your
organization a better risk to insure.
Principles of risk management

The International Organization for Standardization identifies the following
principles of risk management:
Risk management should:
• create value.
• be an integral part of organizational processes.
• be part of decision making.
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• explicitly address uncertainty.
• be systematic and structured.
• be based on the best available information.
• be tailored.
• take into account human factors.
• be transparent and inclusive.
• be dynamic, iterative and responsive to change.
• be capable of continual improvement and enhancement.
According to the standard ISO 31000 "Risk management -- Principles and

guidelines on implementation," the process of risk management consists of several
steps as follows:
1. Identification of risk in a selected domain of interest

2. Planning the remainder of the process.
3. Mapping out the following:
o the social scope of risk management
o the identity and objectives of stakeholders
o the basis upon which risks will be evaluated, constraints.
4. Defining a framework for the activity and an agenda for identification.
5. Developing an analysis of risks involved in the process.
Assessment
Once risks have been identified, they must then be assessed as to their potential
severity of loss and to the probability of occurrence. These quantities can be either
simple to measure, in the case of the value of a lost building, or impossible to
know for sure in the case of the probability of an unlikely event occurring.
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Therefore, in the assessment process it is critical to make the best educated guesses
possible in order to properly prioritize the implementation of the risk management
plan.
The fundamental difficulty in risk assessment is determining the rate of occurrence

since statistical information is not available on all kinds of past incidents.
Furthermore, evaluating the severity of the consequences (impact) is often quite
difficult for immaterial assets. Asset valuation is another question that needs to be
addressed. Thus, best educated opinions and available statistics are the primary
sources of information. Nevertheless, risk assessment should produce such
information for the management of the organization that the primary risks are easy
to understand and that the risk management decisions may be prioritized. Thus,
there have been several theories and attempts to quantify risks. Numerous different
risk formulae exist, but perhaps the most widely accepted formula for risk
quantification is:
Rate of occurrence multiplied by the impact of the event equals risk
Later research] has shown that the financial benefits of risk management are less
dependent on the formula used but are more dependent on the frequency and how
risk assessment is performed.
In business it is imperative to be able to present the findings of risk assessments in

financial terms. Robert Courtney Jr. (IBM, 1970) proposed a formula for
presenting risks in financial term.The Courtney formula was accepted as the
official risk analysis method for the US governmental agencies. The formula
proposes calculation of ALE (annualised loss expectancy) and compares the
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expected loss value to the security control implementation costs (cost-benefit
analysis).
Potential risk treatments

Once risks have been identified and assessed, all techniques to manage the risk fall
into one or more of these four major categories.
• Avoidance (eliminate, withdraw from or not become involved)

• Reduction (optimise - mitigate)
• Sharing (transfer - outsource or insure)
• Retention (accept and budget)
Risk avoidance
Includes not performing an activity that could carry risk. An example would be not
buying a property or business in order to not take on the liability that comes with it.
Another would be not flying in order to not take the risk that the airplane were to
be hijacked. Avoidance may seem the answer to all risks, but avoiding risks also
means losing out on the potential gain that accepting (retaining) the risk may have
allowed. Not entering a business to avoid the risk of loss also avoids the possibility
of earning profits.
Risk reduction
Risk reduction or "optimisation" involves reducing the severity of the loss or the
likelihood of the loss from occurring. For example, sprinklers are designed to put
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out a fire to reduce the risk of loss by fire. This method may cause a greater loss by
water damage and therefore may not be suitable. Halon fire suppression systems
may mitigate that risk, but the cost may be prohibitive as a strategy.
Acknowledging that risks can be positive or negative, optimising risks means

finding a balance between negative risk and the benefit of the operation or activity;
and between risk redution and effort applied. By an offshore drilling contractor
effectively applying HSE Management in its organisation, it can optimise risk to
achieve levels of residual risk that are tolerable.
Modern software development methodologies reduce risk by developing and

delivering software incrementally. Early methodologies suffered from the fact that
they only delivered software in the final phase of develpment; any problems
encountered in earlier phases meant costly rework and often jeopardized the whole
project. By developing in iterations, software projects can limit effort wasted to a
single iteration.
Outsourcing could be an example of risk reduction if the outsourcer can

demonstrate higher capability at managing or reducing risks.For example, a
company may outsource only its software development, the manufacturing of hard
goods, or customer support needs to another company, while handling the business
management itself. This way, the company can concentrate more on business
development without having to worry as much about the manufacturing process,
managing the development team, or finding a physical location for a call center.
Risk sharing
Briefly defined as "sharing with another party the burden of loss or the benefit of
gain, from a risk, and the measures to reduce a risk."
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The term of 'risk transfer' is often used in place of risk sharing in the mistaken
belief that you can transfer a risk to a third party through insurance or outsourcing.
In practice if the insurance company or contractor go bankrupt or end up in court,
the original risk is likely to still revert to the first party. As such in the terminology
of practitioners and scholars alike, the purchase of an insurance contract is often
described as a "transfer of risk." However, technically speaking, the buyer of the
contract generally retains legal responsibility for the losses "transferred", meaning
that insurance may be described more accurately as a post-event compensatory
mechanism. For example, a personal injuries insurance policy does not transfer the
risk of a car accident to the insurance company. The risk still lies with the policy
holder namely the person who has been in the accident. The insurance policy
simply provides that if an accident (the event) occurs involving the policy holder
then some compensation may be payable to the policy holder that is commensurate
to the suffering/damage.
Some ways of managing risk fall into multiple categories. Risk retention pools are
technically retaining the risk for the group, but spreading it over the whole group
involves transfer among individual members of the group. This is different from
traditional insurance, in that no premium is exchanged between members of the
group up front, but instead losses are assessed to all members of the group.
1. to evaluate whether the previously selected security controls are still

applicable and effective, and
2. to evaluate the possible risk level changes in the business environment. For
example, information risks are a good example of rapidly changing business
environment.
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Limitations
If risks are improperly assessed and prioritized, time can be wasted in dealing with
risk of losses that are not likely to occur. Spending too much time assessing and
managing unlikely risks can divert resources that could be used more profitably.
Unlikely events do occur but if the risk is unlikely enough to occur it may be better
to simply retain the risk and deal with the result if the loss does in fact occur.
Qualitative risk assessment is subjective and lacks consistency. The primary
justification for a formal risk assessment process is legal and bureaucratic.
Prioritizing the risk management processes too highly could keep an organization
from ever completing a project or even getting started. This is especially true if
other work is suspended until the risk management process is considered complete.
It is also important to keep in mind the distinction between risk and uncertainty.
Risk can be measured by impacts x probability.
Areas of risk management
As applied to corporate finance, risk management is the technique for measuring,

monitoring and controlling the financial or operational risk on a firm's balance
sheet. See value at risk.
The Basel II framework breaks risks into market risk (price risk), credit risk and
operational risk and also specifies methods for calculating capital requirements for
each of these components.
interest rate risk

Definition
29
The possibility of a reduction in the value of a security, especially a bond, resulting
from a rise in interest rates. This risk can be reduced by diversifying the durations
of the fixed-income investments that are held at a given time.
The chance that a security's value will change due to a change in interest rates. For
example, a bond's price drops as interest rates rise. For a depository institution,
also called funding risk: The risk that spread income will suffer because of a
change in interest rates.
The risk that interest rates will rise and reduce the market value of an investment.
Long-term fixed-income securities, such as bonds and preferred stock, subject their
owners to the greatest amount of interest rate risk. Short-term securities, such as
Treasury bills, are influenced much less by interest rate movements. Common
stock prices are also affected by changes in interest rates, although the linkage is
less clear than is the case with debt securities and preferred stock.
The risk of loss due to a change in interest rates. Interest rate risk is important to
transactions like interest rate swaps. In such a transaction, the party receiving the
floating rate will receive a smaller amount should the floating rate decrease.
Interest rate risk is also important to bonds; if interest rates rise, the prices of bonds
fall. This affects the secondary market for bonds; for example, if one purchases a
bond with a 3% interest rate and the prevailing rate rises to 5%, it becomes
difficult or impossible to resell the bond at a profit. Finally, interest rate risk is
important to project finance. If interest rates rise, funding may not be available for
a new loan for a project that has already started.
The risk of loss due to a change in interest rates. Interest rate risk is important to
transactions like interest rate swaps. In such a transaction, the party receiving the
floating rate will receive a smaller amount should the floating rate decrease.
Interest rate risk is also important to bonds; if interest rates rise, the prices of bonds
30
fall. This affects the secondary market for bonds; for example, if one purchases a
bond with a 3% interest rate and the prevailing rate rises to 5%, it becomes
difficult or impossible to resell the bond at a profit. Finally, interest rate risk is
important to project finance. If interest rates rise, funding may not be available for
a new loan for a project that has already started.
Repricing risk
The risk presented by assets and liabilities that reprice at different times and
rates. For instance, a loan with a variable rate will generate more interest
income when rates rise and less interest income when rates fall. If the loan is
funded with fixed rated deposits, the bank's interest margin will fluctuate.
Option risk
It is presented by optionality that is embedded in some assets and liabilities.

For instance, mortgage loans present significant option risk due to
prepayment speeds that change dramatically when interest rates rise and fall.
Falling interest rates will cause many borrowers to refinance and repay their
loans, leaving the bank with uninvested cash when interest rates have
declined. Alternately, rising interest rates cause mortgage borrowers to repay
slower, leaving the bank with more loans based on prior, lower interest rates.
Option risk is difficult to measure and control.
Futures and options

Futures and options represent two of the most common form of "Derivatives".
Derivatives are financial instruments that derive their value from an 'underlying'.
The underlying can be a stock issued by a company, a currency, Gold etc., The
derivative instrument can be traded independently of the underlying asset.
31
The value of the derivative instrument changes according to the changes in the
value of the underlying.
Derivatives are of two types exchange traded and over the counter.
Exchange traded derivatives, as the name signifies are traded through organized
exchanges around the world. These instruments can be bought and sold through
these exchanges, just like the stock market. Some of the common exchange traded
derivative instruments are futures andoptions.
Over the counter (popularly known as OTC) derivatives are not traded through the
exchanges. They are not standardized and have varied features. Some of the
popular OTC instruments are forwards, swaps, swaptions etc.
Futures
A 'Future' is a contract to buy or sell the underlying asset for a specific price at a
pre-determined time. If you buy a futures contract, it means that you promise to
pay the price of the asset at a specified time. If you sell a future, you effectively
make a promise to transfer the asset to the buyer of the future at a specified price at
a particular time. Every futures contract has the following features:
• Buyer
• Seller
• Price
• Expiry
Some of the most popular assets on which futures contracts are available are equity
stocks, indices, commodities and currency.
The difference between the price of the underlying asset in the spot market and the
futures market is called 'Basis'. (As 'spot market' is a market for immediate
32
delivery) The basis is usually negative, which means that the price of the asset in
the futures market is more than the price in the spot market. This is because of the
interest cost, storage cost, insurance premium etc., That is, if you buy the asset in
the spot market, you will be incurring all these expenses, which are not needed if
you buy a futures contract. This condition of basis being negative is called as
'Contango'.
Sometimes it is more profitable to hold the asset in physical form than in the form
of futures. For eg: if you hold equity shares in your account you will receive
dividends, whereas if you hold equity futures you will not be eligible for any
dividend.
When these benefits overshadow the expenses associated with the holding of the
asset, the basis becomes positive (i.e., the price of the asset in the spot market is
more than in the futures market). This condition is called 'Backwardation'.
Backwardation generally happens if the price of the asset is expected to fall.
It is common that, as the futures contract approaches maturity, the futures price and
the spot price tend to close in the gap between them ie., the basis slowly becomes
zero.
33
RESEARCH OBJECTIVES
34
OBJECTIVES OF RESEARCH
REPORT
1.To study about the foreign exchange
regulations.
2.To understand the features and working of
foreign exchange markets.
3.To be aware of the exchange control
regulations governing forward contracts.
4.To appreciate the role of IMF in global
exchange role systems.
5.To get acquainted with the procedure for
booking forward contracts
6.To know interest rate risk on business
enterprise.
35
RESEARCH METHODOLOGY
36
Research Methodology
Research is a systematic, scientific and objective way of searching for knowledge.
It is a scientific and systematic search for information of specific topic. It is careful
investigation or inquiry for search of new facts in any branch of knowledge.
The research means defining the problem for formulating the hypothesis, collecting,
organizing and evaluation data, reaching conclusion and at last carefully testing the
conclusion to determine whether they fit the formulated hypothesis.
 Type of Research: - Descriptive research, in this research the researcher

analyses all the data critically.
37
 Data Collection Method :- Collection of data is secondary i.e. CMIE
Database, Newspaper, Book, Magazines, Searching website,
 Statistical Tools: - Graphs, Charts, Tables, Bar diagrams etc.
ANALSYSIS
38
Analysis of Objective 1
 To get an overview of foreign exchange regulations.
The Foreign Exchange Regulation Act of 1973 (FERA) in India was repealed on 1
June, 2000. It was replaced by the Foreign Exchange Management Act (FEMA),
which was passed in the winter session of Parliament in 1999. Enacted in 1973, in
the backdrop of acute shortage of Foreign Exchange in the country, FERA had a
controversial 27 year stint during which many bosses of the Indian Corporate
world found themselves at the mercy of the Enforcement Directorate (E.D.). Any
offense under FERA was a criminal offense liable to imprisonment, whereas
FEMA seeks to make offenses relating to foreign exchange civil offenses.
39
FEMA, which has replaced FERA, had become the need of the hour since FERA
had become incompatible with the pro-liberalisation policies of the Government of
India. FEMA has brought a new management regime of Foreign Exchange
consistent with the emerging frame work of the World Trade Organisation (WTO).
It is another matter that enactment of FEMA also brought with it Prevention of
Money Laundering Act, 2002 which came into effect recently from 1 July, 2005
and the heat of which is yet to be felt as “Enforcement Directorate” would be
invesitigating the cases under PMLA too.
Unlike other laws where everything is permitted unless specifically prohibited, under FERA
nothing was permitted unless specifically permitted. Hence the tenor and tone of the Act was
very drastic. It provided for imprisonment of even a very minor offence. Under FERA, a person
was presumed guilty unless he proved himself innocent whereas under other laws, a person is
presumed innocent unless he is proven guilty.
To study the features and working of foreign exchange markets.
The foreign exchange market is the mechanism by which

currencies are valued relative to one another, and exchanged. An
individual or institution buys one currency and sells another in a
simultaneous transaction. Currency trading always occurs in pairs
where one currency is sold for another and is represented in the
following notation: EUR/USD or CHF/YEN. The exchange rate is
determined through the interaction of market forces dealing with
supply and demand.
40
Foreign Exchange Traders generate profits, or losses, by speculating whether a
currency will rise or fall in value in comparison to another currency. A trader
would buy the currency which is anticipated to gain in value, or sell the currency
which is anticipated to lose value against another currency. The value of a
currency, in the simplest explanation, is a reflection of the condition of that
country's economy with respect to other major economies. The Forex market does
not rely on any one particular economy. Whether or not an economy is flourishing
or falling into a recession, a trader can earn money by either buying or selling the
currency. Reactive trading is the buying or selling of currencies in response to
economic or political events, while speculative trading is based on a trader
anticipating events.
The 8 Major Currencies:
Whereas there are thousands of securities on the stock market, in the FOREX
market most trading takes place in only a few currencies; the U.S. Dollar ($),
European Currency Unit (€), Japanese Yen (¥), British Pound Sterling (£), Swiss
Franc (Sf), Canadian Dollar (Can$), and to a lesser extent, the Australian and New
Zealand Dollars. These major currencies are most often traded because they
represent countries with esteemed central banks, stable governments, and relatively
low inflation rates.
Currencies are also always traded in pairs (i.e. USD/JPY or Dollar/Yen) at floating
exchange rates.
Trading volumes in a given region are always highest during its

primary business hours, when traders at financial institutions are
busy filling and placing orders. The most active times, meaning
the times of most liquidity and movement in the markets, is the
41
London open (3 AM EST), and the overlap between London/Euro
close and New York's open (8-11 AM EST).
The hours below correspond to someone living in the EST time

zone.
• New York session opens at 8:00 am and ends around 5:00

pm.
• Sydney session starts at 5:00 pm and ends around 2:00 am.
• Tokyo session begins at 7:00 pm and ends around 4:00 am.
• Frankfurt session opens at 2:00 am and ends around 11:00
am.
• London opens at 3:00 am and ends around 12:00 am.
Below is a figure showing business hours in the various regions,

oriented for someone in the EST time zone. In this figure you can
see the overlap between the European/London session and the
New York session, between 8 am and 11 am EST. The currency
markets experience the highest volatility and volume during that
overlap, which also coincides with the release of important US
economic figures.
42
speculation.
43
has no recourse.
the currencies.
10. A currency swap is the simultaneous purchase and sale of a given amount of currency at two
different dates and values.
 To be aware of the exchange control regulations governing forward
contracts.
44
speculation.
45
has no recourse.
the currencies.
10. A currency swap is the simultaneous purchase and sale of a given amount of
currency at two different dates and values.
To appreciate the role of IMF in global exchange role
systems.
Rates Of Exchange.
Sight draft or check ............ 485.25
+ Int. 10 ds. 3 % approx ........ .37 ½
485.62 ½
Bankers' bills, or where documents are to be surren-
dered on acceptance.
Demand ............ 485.25
46
Less Stamp .......... .24
Interest 68 ds. 2 7/8%..... 2.41 2.65
482.60
60 days bills with documents attached which
are to be surrendered on payment of the bill.
Quotation for demand.... 485.25
Less stamp ........ .24
2% int.63days........ 1.68 1.92
483.33
Telegraphic Transfers.
Marks. Demand............. 95.25
Interest 10 days 3 1/4%......... .08
95.33
Bankers' bills, clean commercial bills, or such with
documents to be surrendered on acceptance.
Demand........... 95.25
Stamp ½ %......... .48
Int. 60 days 3 1/4 %....... 5.12 .56
94.69
Demand .................... 95.25
Stamp 1/2%......... .48
Int. 60 days 4% (Bank rate). 6.32 .68
94.57
Francs.
T /T *
Demand........... • • • • • • • 5.18.25
47
Less 10 days int. 3%..... .43
(517 1/2 - 1-32 = 517.66), 5.17.82
Commercial bills with documents to be surrendered on payment under rebate of

interest at bank rate in the event of the bill being paid prior to maturity.In
determining the value of time bills, other items 01 cost must be taken into
consideration, such as commissions to be paid to bankers abroad for handling the
items, etc.
In discounting bills in England it must be noted that the 3 days of grace allowed by
law are taken into consideration in calculating the discount while on the continent,
48
where grace is also customary, only 60 days are brought into computation. Days of
grace, as applied on the continent, have relation only to the notarial act of protest in
the event of non-payment - i. e. if a bill matures on Jan. 1 and is not paid, it will
not be protested until three working days thereafter. On the other hand it is
customary in Germany, when discounting a batch of bills, to apply the bank rate on
5 days and the current rate on the remaining days the bills have to run.
49
To get acquainted with the procedure for booking
forward contracts
Derivatives are financial instruments that derive their value from
an 'underlying'. The underlying can be a stock issued by a
company, a currency, Gold etc., The derivative instrument can be
traded independently of the underlying asset.
The value of the derivative instrument changes according to the
changes in the value of the underlying.
Derivatives are of two types exchange traded and over the
counter.
Exchange traded derivatives, as the name signifies are traded
through organized exchanges around the world. These
instruments can be bought and sold through these exchanges,
just like the stock market. Some of the common exchange traded
derivative instruments are futuresand options.
Over the counter (popularly known as OTC) derivatives are not

traded through the exchanges. They are not standardized and
have varied features. Some of the popular OTC instruments are
forwards, swaps, swaptions etc.
50
The difference between the price of the underlying asset in the
spot market and the delivery) The basis is usually negative, which
means that the price of the asset in the futures market is more
than the price in the spot market. This is because of the interest
cost, storage cost, insurance premium etc., That is, if you buy the
asset in the spot market, you will be incurring all these expenses,
which are not needed if you buy a futures contract. This condition
of basis being negative is called as 'Contango'.
Sometimes it is more profitable to hold the asset in physical form

than in the form of futures. For eg: if you hold equity shares in
your account you will receive dividends, whereas if you hold
equity futures you will not be eligible for any dividend.
When these benefits overshadow the expenses associated with

the holding of the asset, the basis becomes positive (i.e., the
price of the asset in the spot market is more than in the futures
market). This condition is called 'Backwardation'. Backwardation
generally happens if the price of the asset is expected to fall.
It is common that, as the futures contract approaches maturity,

the futures price and the spot price tend to close in the gap
between them ie., the basis slowly becomes zero.
51
To know interest rate risk on business enterprise.
Risk management ensures that an organization identifies and understands the risks
to which it is exposed. Risk management also guarantees that the organization
creates and implements an effective plan to prevent losses or reduce the impact if a
loss occurs.
A risk management plan includes strategies and techniques for recognizing and
confronting these threats. Good risk management doesn’t have to be expensive or
time consuming; it may be as uncomplicated as answering these three questions:
Benefits of managing risk

Risk management provides a clear and structured approach to identifying risks.
Having a clear understanding of all risks allows an organization to measure and
prioritize them and take the appropriate actions to reduce losses. Risk management
has other benefits for an organization, including:
52
• Saving resources: Time, assets, income, property and people
are all valuable resources that can be saved if fewer claims
occur.
• Protecting the reputation and public image of the
organization.
• Preventing or reducing legal liability and increasing the
stability of operations.
• Protecting people from harm.
• Protecting the environment.
• Enhancing the ability to prepare for various circumstances.
• Reducing liabilities.
• Assisting in clearly defining insurance needs.
An effective risk management practice does not eliminate risks.

However, having an effective and operational risk management
practice shows an insurer that your organization is committed to
loss reduction or prevention. It makes your organization a better
risk to insure.
In ideal risk management, a prioritization process is followed whereby the risks

with the greatest loss and the greatest probability of occurring are handled first,
and risks with lower probability of occurrence and lower loss are handled in
descending order. In practice the process can be very difficult, and balancing
between risks with a high probability of occurrence but lower loss versus a risk
with high loss but lower probability of occurrence can often be mishandled.
Intangible risk management identifies a new type of a risk that has a 100%
probability of occurring but is ignored by the organization due to a lack of
identification ability. For example, when deficient knowledge is applied to a
53
situation, a knowledge risk materializes. Relationship risk appears when ineffective
collaboration occurs. Process-engagement risk may be an issue when ineffective
operational procedures are applied. These risks directly reduce the productivity of
knowledge workers, decrease cost effectiveness, profitability, service, quality,
reputation, brand value, and earnings quality. Intangible risk management allows
risk management to create immediate value from the identification and reduction
of risks that reduce productivity.
Risk management also faces difficulties allocating resources. This is the idea of opportunity
cost. Resources spent on risk management could have been spent on more profitable activities.
Again, ideal risk management minimizes spending and minimizes the negative effects of risks.
FINDINGS
1-To facilitate the smooth functioning of the arrangement , the signatures of the
authorized officials of the banks who will sign the documents and letters on behalf
of respective banks are exchanged between the banks.
2- The term foreign exchange market is used to refer to the wholesale segment of
the market , where the dealings take place among the banks , The retail segment
refers to the dealings that take place between banks and their customers . the retail
segment is situated at the large number of place . The retail market can be
considered the counter of the forcing exchange market.
3- A forward contract is an agreement to buy or sell a specified amount of a

foreign currency on a specified future date at a predetermined exchange rate
.forward contracts completely eliminate the exchange risk .but they also take away
the chances of gaining from favourable movements in exchange rates.
4- Multinational Investment Guarantee Agency provides guarantee to private

against the risk of transfer restriction ,expropriation ,war and civil disturbance and
breach of contract.
54
Asian develement Bank is the multilateral agency financing principally projects in
Asia-Pacific region.
5- Interest rate options allow the buyer of the options to borrow or lend the
specified amount of specified currency at a specified future date at a specified rate
of interest without any obligation to do so.A call option invests the buyer with right
to borrow and a put option invest him with right to invest
CONCLUSION
55
CONCLUTION
Foreign exchange is the mechanism by which the currency of one country gets
converted into the currency of another country . This is carried out through the
intermediation of banks .The term also refers to foreign currencies and balance in
foreign currencies held abroad . Foreign Exchange is required for settlement of
economic transactions between residents of two countries .The transactions may
relate to trade in goods and services , capital flows and personal remittances.The
Asian crisis has shown timely warnings signals to India in its march towards
liberalisation. India should continue to follow the path of progressive liberalisation
with continuous assment and judicious monitoring.
With greater awareness,companies are now devoting more time in managing

economic exposure also. In world of competition and liberalisation , the survival
and growth of business enterprises depends significantly on how well they
recognize and manage effectively the exchange risk and exposure.
56
LIMITATIONS
57
Limitations
Project is based on secondary data. Since, secondary data is derived for other
purpose, so it can not completely fulfill all the objectives for which I have to
conduct my project.
I have also taken data from various resources like website, book etc. If there is any
error committed by writer or administrator then my result also may be affected.
There is also shortage of time, money and other resources
58
BIBLIOGRAPHY
59
BIBLOGRAPHY
Research Methodology – C.R.Kothari
Foreign exchange and risk management- C. Jeevanadam
International Business and Risk Management- Francis

Cherunilam
International Economics – D.M. Mithani
SEARCH INTERNET-
www.google.com
ww
w.scribd.com
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TABLE OF CONTENT

With an ineffable sense of gratitude’s I take this opportunity to express my deep

I would like to thank all my teachers specially coordinators Mr.Wamique Hisam

This survey report had been conducted

The Basics of the Foreign Exchange Market

• The characteristics of foreign exchange and how it differs from other

Meaning of forex exchange.

A sophisticated individual who trades with significant leverage, taking on above

A Short History of the Foreign Exchange Trading

Margin in the context of FX & CFDs

The Arithmetic Of Exchange

Sterling. Tel. Transfers. Sight. 60 days.

1. Posted rates. These are rates arbitrarily determined by international bankers in

Foreign Exchange Management Act

Unlike other laws where everything is permitted unless specifically prohibited,

Meaning of Foreign-Exchange Risk

The AFEM metamorphosed into a daily, two-way quote Inter-Bank Foreign

Exchange Rate Movement

Exchange rate risk

Similarly an exporter is likely to find that an appreciation in its domestic currency

Historically, Forex has been dominated by inter-world investment and commercial

The Functions of the Foreign Exchange Market

Meaning of risk management

Benefits from managing risk

Principles of risk management

Risk management should:

According to the standard ISO 31000 "Risk management -- Principles and

1. Identification of risk in a selected domain of interest

The fundamental difficulty in risk assessment is determining the rate of occurrence

Rate of occurrence multiplied by the impact of the event equals risk

In business it is imperative to be able to present the findings of risk assessments in

Potential risk treatments

• Avoidance (eliminate, withdraw from or not become involved)

Acknowledging that risks can be positive or negative, optimising risks means

Modern software development methodologies reduce risk by developing and

Outsourcing could be an example of risk reduction if the outsourcer can

1. to evaluate whether the previously selected security controls are still

Areas of risk management

As applied to corporate finance, risk management is the technique for measuring,

interest rate risk

It is presented by optionality that is embedded in some assets and liabilities.

Futures and options

 Type of Research: - Descriptive research, in this research the researcher

 Statistical Tools: - Graphs, Charts, Tables, Bar diagrams etc.

To study the features and working of foreign exchange markets.

The foreign exchange market is the mechanism by which

The 8 Major Currencies:

Trading volumes in a given region are always highest during its

The hours below correspond to someone living in the EST time

• New York session opens at 8:00 am and ends around 5:00

Below is a figure showing business hours in the various regions,

Commercial bills with documents to be surrendered on payment under rebate of

Over the counter (popularly known as OTC) derivatives are not

Sometimes it is more profitable to hold the asset in physical form

When these benefits overshadow the expenses associated with

It is common that, as the futures contract approaches maturity,

Benefits of managing risk

An effective risk management practice does not eliminate risks.

In ideal risk management, a prioritization process is followed whereby the risks

3- A forward contract is an agreement to buy or sell a specified amount of a

4- Multinational Investment Guarantee Agency provides guarantee to private

With greater awareness,companies are now devoting more time in managing