Banking and Finance- Spl IV

PRESENTATION

By: Name
Roll No.
Komal Rana
5601
Sanchi Agarwal
5612
Simran Agarwal
5617
Nikita Sharma
5633
Management of Foreign
Exchange Risk
 Definition
Foreign Exchange Market:
A market for the purchase and sale of
foreign currencies is called a foreign
exchange market.
Exchange Risk:
It is a potential gain or loss that occurs as
a result of an exchange rate change.
Uncovered claim in foreign currency is
called long and an uncovered liability in
foreign currency is called short.
 Characteristics
O Electronic Market
O Geographical dispersal
O Transfer of purchasing power
O Intermediary
O Volume
O Provision of credit
O Minimizing risks
 Participants

O Foreign exchange dealers

O Individuals and firms
O Speculators and arbitragers
O Central banks and Treasuries
O Foreign exchange brokers
 Risks
O Transaction exposure: The net amount of
existing commitments to make or receive
in outlays in foreign currency.
O Translation exposure: The net book value
of assets and liabilities denominated in a
foreign currency arising out of changes in
exchange rates.
O Economic Exposure: The risks that are
associated with the changes in the present
value of a firm, an asset or a liability on
account of the exchange rate changes.
Should firms manage
foreign exchange
risk ?
Firms refrain from management of foreign
exchange risk because
O Management does not understand it.
O They claim that exposure cannot be
measured.
O They say that the firm is hedged.
O They say that the firm does not have any
exchange risk because it does all its
business in rupees.
O They assert that the balance sheet is
hedged on an accounting basis.
Risk Management
Tools
 Hedging
O The method of securing oneself against
loss from various risks is called hedging.
O Hedging is used as a potential tool to
ward off or offset the deleterious effects
impending exchange risks by altering the
composition of assets and liabilities.
O Hedges avoid exchange risk by matching
their assets and liabilities in foreign
currencies.
 Forward Contract
OA contract between banks
which calls for delivery, at a
future date, of a specified
amount of one currency against
dollar payments at the rate
which is determined at the time
of the contract is known as a
forward contract.
 Hedging with Forward Contract
O Hedging a long position: Where an Indian
exporter, owning a foreign currency claim in
the form of an export bill in foreign
currency(US dollars), expects the value of
dollar to fall on the date of collection of the
bill in future, the sale of forward contract will
help guarantee the Indian exporter, the actual
price.
O Hedging a short position: Where an Indian
importer, owing a foreign currency liability in
the form of an import bill obligation in foreign
currency(US dollars), expects the value of
dollar to increase on the date of payment of
 Currency Futures
O This are similar to forwards in that they are
contracts for delivery of a certain amount of a
foreign currency at some future date and at a
known price.
O One difference between forwards and futures
is standardization. Forwards are for any
amount while futures are for standard
amounts.
O In Forwards, trading takes place through the
mechanism of telecommunication linkages,
while in Futures, it takes place on the floor of
organized exchanges.
 Money Market Hedge
Combines spot exchange transaction with a
money market transaction.
O Long position: Where an Indian exporter,
owning a foreign currency claim in the form of
an export bill in foreign currency(US dollars),
expects the value of dollar to fall on the date
of collection of the bill in future, borrowing in
US dollars will help guarantee the Indian
exporter the, the actual price.
O Short position: Where an Indian importer,
owing a foreign currency liability in the form of
an import bill obligation in foreign currency(US
dollars), expects the value of dollar to
increase on the date of payment of the bill in
 Currency Option
Example:
A computer manufacturer in California may
have sales priced in US dollars as well as in
German marks in Europe. Depending in the
relative strength of the two currencies, revenues
may be realized in either German marks or
dollars. In such a situation the use of forward or
futures would be inappropriate: there is no point
in hedging something you might not have. What
is called for is a foreign exchange option.
Currency option is
a derivative financial instrument
that gives the right but not the
obligation to exchange money
denominated in one currency at
a pre-agreed exchange rate on a
specified date.
primarily used to hedge
uncertain future cash flows in a
foreign currency.
 Currency Arbitrage
O Buying currency in one market and selling
the same in another market is called
currency arbitrage.
O It provides an opportunity to foreign
exchange dealers to benefit from
differences in exchange rates prevailing in
many financial centers of the world.
O It is possible to buy foreign currency in
one market at a lower rate and sell it in
another market at a higher rate. Through
this process, dealers make profit.
Source
Financial Markets
by Guruswamy