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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
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FOREIGN RISK & EXPOSURE
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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
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TYPES OF RISK
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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.
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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.
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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.
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Risk Exposure
Definition
Valuation
Hedging
Concept
DIFFERENTIATION
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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
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RISK FACE D BY COMMERCIAL BANK
IN FOREX MARKET
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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
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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
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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.
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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.
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HE DGING IN FOREX MARKET
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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
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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.
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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.
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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.
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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.
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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
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HE DGING BY CONTRACTS AND INSTRUMENTS
Forward contract
Future contract
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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
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FORWAR D CONTRACT
A highly standardized foreign exchange contract written against the
exchange clearing house.
Features
Standardization
Organized exchanges
Cash Settlement
Costs
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Forward Contract Future Contract
Contract Size
Maturity Date
Liquidity
Hedging Perfection
Settlement
DIFFERENTIATION
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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
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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
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AD VANTAGEOUS FEATURES
Leverage
Liquidity
Suitable for uncertain transactions
No default or settlement risk
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TYPES OF OPTION CONTRACT
European Option
American Option
Bermudan Option
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OTHER HE DGING CONCEPTS
Interest Rate Swap
Currency Swap
Money Market Hedge