risk (exposure) & hedging in forex market

8/3/2019 Risk (Exposure) & Hedging In Forex Market

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MohammedDanish

M-4155

Mayank Sharma

M-4153

Ayaz Momin

M-4156

Muqsit PatelM-4132

Vishal Gajjar

M-4110



FOREIGN RISK & EXPOSURE



PECULIARITIES THAT MAKES

BUSINESS RISKY

Controls & Restrictions Imposed By Foreign Authorities

Fluctuation In The Currency Rates

24 Hours Global Market

Forex Rates Move Considerably

Decision Making In Forex Market



TYPES OF RISK



The exchange rate risk associated with the time delay between entering into a contract and settling

it. The greater the time differential between the entrance and settlement of the contract, the greater

the transaction risk, because there is more time for the two exchange rates to fluctuate.



The exchange rate risk associated with companies that deal in foreign currencies or list foreign

assets on their balance sheets. The greater the proportion of asset, liability and equity classes

denominated in a foreign currency, the greater the translation risk.



Economic exposure measures the impact of changes in exchange rate on the firm·s & cash flows and

earnings. Exchange rates, interest rates and inflation rates are linked to one another through a

classical set of relationships which have import for the nature of corporate foreign exchange risk.



Risk Exposure

Definition

Valuation

Hedging

Concept

DIFFERENTIATION



RISK FACE D BY COMMERCIAL BANK

IN FOREX MARKET

INTRODUCTION

When the foreign currency denominated assets & liabilities are held by the bank two

types of risk are faced....

Exchange Risk

Interest Rate Risk



RISK FACE D BY COMMERCIAL BANK

IN FOREX MARKET



The exchange risk on the net open Forex position is called the ¶Position Risk·

For E.g. where a net long position is in currency whose value is depreciating , the conversion of

currency will resulting in a loss, a lower amount of the corresponding currency resulting in a loss

whereas a net long position in an appreciating currency would result in a profit.

The most popular controls on open position risk are :

1. Daylight limit

2. Overnight limit



Where a foreign currency is bought and sold for different value dates , it creates

no net position i.e. there is no Forex risk

Mismatches expose one to risks of exchange losses that arises out of adverse

moment in forward points and therefore controls need to be initiated

The limits on GAP Risk are:

1.Individual gap limit2. Aggregate gap limit

3. Total aggregate gap limit



Banks square off their bid ask position.

Such square off may not be favorable in terms of rates.

Pre-settlement risk leads to replacement risk.



If the customer fails to honor his contract on the day of settlement, then it is

called as settlement risk

Settlement risk also leads to replacement risk

Also one day delay would cause an extra interest payable by bank.



HE DGING IN FOREX MARKET



INTRODUCTION

Hedging refers to risk management strategy used in limiting or offsetting

probability of loss from fluctuations in the prices of commodities, currencies or

securities

Hedging is used also in protecting one·s capital against effects of inflation

through investing in high yield financial instruments, real estate, or precious

metals.

By utilizing a forex hedge properly, a trader that is a long a foreign currencypair, can protect themselves from downside risk; while the trader that is short

a foreign currency pair can protect against upside risk



NEE D TO COVER FOREX EXPOSURE

As by & large Purchase Power Parity (PPP) & Interest Rate Parity (IRP) hold well, exchange rate

move accordingly and hence there is no need to cover risk for Forex rate change over a period of

time

Large MNCs have significant exposure in most strong currency. It is difficult to forecast change in

each of them.

Investor themselves are insulated by way of diversification from such risk.

Mitigation measures are exposure in opposite direction.



FOR

Forex risk holds potential of financial loss. Hedging reduces the possibilities

By & Large, natural hedging is used, for which costs are not explicit. Only the residual portion ishedged through instruments.

With open positions, budgeting planning is tough

Managing Forex Risk

Hedging may create administrative benefits.



AGAINST

If markets are ¶near-efficient·, then there is almost equilibrium in the market

Open position may result in marginal loss or marginal gain and on average, it would be really smallamount lost or gained

Futures, option may result in losses also.

Shareholders can diversify their own portfolios to compensate for forex risk.

Risk mitigation is just a psychological comfort, with costs.



FOREX HE DGING STRATEGY

Analyze Risk

Determine Risk Tolerance

Determine forex hedging strategy

Implement & Monitor the strategy

The forex currency trading market is a risky one.



NATURAL HE DGING

Natural hedging refers to operational changes that mitigate or eliminate forex risk

without use of financial instrument or derivates.

Currency denomination

Netting and offsetting

Leading and lagging



HE DGING BY CONTRACTS AND INSTRUMENTS

Forward contract

Future contract



FORWAR D CONTRACT

It is the simplest form of contract in foreign exchange market.

Features

It is Tailor made

It is a perfect hedge

Not available to all

Not cancellable



FORWAR D CONTRACT

A highly standardized foreign exchange contract written against the

exchange clearing house.

Features

Standardization

Organized exchanges

Cash Settlement

Costs



Forward Contract Future Contract

Contract Size

Maturity Date

Liquidity

Hedging Perfection

Settlement

DIFFERENTIATION



OPTION CONTRACT

It is optional to one party and obligated to other, is called as ¶option·

Right to buy or sell specific quantity of specific assets at a fix price at or before future date.

Right to buy

Right to sell

Option have standardized quantity

Option are traded on exchanges



FEATURES OF OPTION CONTRACT

Cash settlement, No actual delivery

Market is full of speculators

Option is exercised or lapsed on maturity

Buyer will choose to exercise his option only if he has net gain



AD VANTAGEOUS FEATURES

Leverage

Liquidity

Suitable for uncertain transactions

No default or settlement risk



TYPES OF OPTION CONTRACT

European Option

American Option

Bermudan Option



OTHER HE DGING CONCEPTS

Interest Rate Swap

Currency Swap

Money Market Hedge



THANK YOU.......

risk (exposure) & hedging in forex market

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