FOREX RISK MANAGEMENT
Smita
RISK AND EXPOSURE
Risk: Risk is chance of financial loss that may emerge out of exchange rate changes etc Exposure: Exposure refers to the amount of asset /liability exposed to loss on account of risk of change in exchange rate etc.
T YPES OF EXPOSURES AND RISKS
Transaction Risk Translation Risk Economic or Operational Risk Sovereign Risk Interest Rate Risk Open Position Risk Settlement Risk/Counterparty Risk etc
HOW TO MANAGE TRANSACTION RISK?
Exposure Netting Appropriate choice of currency of invoicing
Lead and Lag Method
Use of Derivatives: Forward, Futures, Options
WHAT IS DERIVATIVES?
Derivatives is a financial instrument which is deriving its value from some underlying asset. This asset can be Stock (share), Commodity, Currency etc. There are four types of Derivatives that are possible: 1. Forward 2. Futures 3. Options and 4. Swaps
FORWARD VS FUTURES
Forward
1. 2. 3.
Futures
1. 2. 3.
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5. 6. 7. 8.
Forward is a over the counter contract. It is between two parties Counterparty risk is high It is a tailor made contract There is no margin system Forward contracts are not marked to market Forward contracts are generally delivery based. Settlement date of forward contract can be any date in future
4.
5. 6. 7.
8.
Futures is an exchange traded contract. It is between three parties. The third part is currency exchange. There is no counterparty risk as counterparty risk is undertaken by the exchange. The futures contract is a standardized contract under which the size of each contract, the settlement date, tick size etc all are decided by the currency exchange. Margin system is must in futures. The margins are marked to market Futures contract is non delivery based contract which are settled through netting. Settlement date for futures contract is generally last day of every month.
HOW TO USE? FORWARD CONTRACT
Hedging
Speculation
HOW TO USE FUTURES CONTRACT?
Hedging
Speculation
SOME TERMS ASSOCIATED WITH FUTURES CONTRACT
Initial margin Maintenance Margin Marked to Market Basis Novation
OPTIONS
An options is a derivative instrument which gives buyer the right but no obligation to purchase/sell the foreign currency and Seller has sold the right to buy foreign currency from him/ sell foreign currency to him. Seller earns/gets premium price for selling the options contract. The premium is non returnable even if the buyer of the contract does not execute it.
1. 2.
Types of Options Contracts are: Call Option Put Option
FREQUENTLY USED TERMS IN CASE OF OPTIONS CONTRACT
Premium Strike Price or Exercise Price and Spot Price
Intrinsic value
Time Value Writer of an Option
VALUE OF AN OPTION
1.
An Options Contract can be: In the Money On the Money Out of Money
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3.
CATEGORIZATION OF OPTION
American Option European Option
Vanilla Option
Exotic Option Naked Option
HOW OPTION CAN BE USED?
Hedging
Speculation
HOW TO MANAGE TRANSLATION RISK
Current -Non Current Method
Monetary Nonmonetary Method
HOW TO MANAGE ECONOMIC/OPERATIONAL RISK?
Change in Input Mix Change in Marketing Strategy Change in Location of Production Creation of New Markets
HOW TO MANAGE INTEREST RATE RISK?
Interest rate Swap Preference for Fixed rate Loans Interest rate Futures Forward rate agreements Currency Swap What are Parallel Loan/Back to Back Loan
HOW TO MANAGE SOVEREIGN RISK?
Appropriate Country Risk analysis Insurance Cover from Specialised agencies like MIGA
OPEN POSITION RISK HOW TO MANAGE?
Exposure Netting Hedging through Forward/Futures/Options
HOW TO MANAGE COUNTERPARTY RISK?
Due Diligence FEDAI Reports
WHAT IS NON-DELIVERABLE FORWARD MARKET?
1. 2. 3.
Features Settlement date is pre-decided NDF Contract rate is pre- decided Reference rate for settling the NDF contract is pre decided.
COMPUTATION
Calculation of Swap Points Calculation of Gain/Loss on a Contract Option or Futures or Forward
