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TitleForex Risk Management
TagsForeign Exchange Market Fixed Exchange Rate System Exchange Rate
File Size873.3 KB
Total Pages114
Table of Contents
                            TABLE: Currency Quotations given by a Bank
CURRENCY
BUYING RATE
SELLING RATE
Rupee/US $
42.3004
42.3120
Rupee /DM
22.2025
22.2080
	6.5 Cross Rate
	
	7.1 Intro to Forward Exchange Market
Premium with respect to ask price
	Discount with respect to ask price
	
		Intrinsic value (American option) = Spot rate -Exercise price
		9.2.1.1 Intrinsic value of Call Option
		Intrinsic value of American put Option
			9.5.1 ANTICIPATION OF APPRECIATIONS OF UNDERLYING 	CURRENCY
TABLE Spot Rate and Financial Impact of Call Option
	9.5.2 ANTICIPATION OF DEPRECIATION OF UNDERLYING 	CURRENCY
	TABLE Spot Rate and Financial Impact of Put Option
		9.5.3 STRADDLE
		9.5.4 SPREAD
		9.7 Other Variants of Options
	10.1 Introduction

10.3 Important Features Of Swaps Contracts
	
	10.4 Reasons for Currency Swap Contracts
	NEWSPAPERS
	BOOKS
                        
Document Text Contents
Page 1

1 RISK MANAGEMENT- AN INTRODUCTION

Risk Management in Forex MarketsRisk Management in Forex Markets

1.1 Risk

Risk can be explained as uncertainty and is usually associated with the

unpredictability of an investment performance. All investments are subject to risk,

but some have a greater degree of risk than others. Risk is often viewed as the

potential for an investment to decrease in value.

Though quantitative analysis plays a significant role, experience, market

knowledge and judgment play a key role in proper risk management. As

complexity of financial products increase, so do the sophistication of the risk

manager’s tools.

We understand risk as a potential future loss. When we take an insurance

cover, what we are hedging is the uncertainty associated with the future events.

Financial risk can be easily stated as the potential for future cash flows (returns) to

deviate from expected cash flows (returns).

There are various factors that give raise to this risk. Return is measured as

Wealth at T+1- Wealth at T divided by Wealth at T. Mathematically it can be

denoted as (WT+1-WT)/WT. Every aspect of management impacting profitability

and therefore cash flow or return, is a source of risk. We can say the return is the

function of:

 Prices,

 Productivity,

 Market Share,

 Technology, and

 Competition etc,

Financial risk management Risk management is the process of measuring

risk and then developing and implementing strategies to manage that risk.

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Risk Management in Forex MarketsRisk Management in Forex Markets

Financial risk management focuses on risks that can be managed ("hedged") using

traded financial instruments (typically changes in commodity prices, interest rates,

foreign exchange rates and stock prices). Financial risk management will also play

an important role in cash management. This area is related to corporate finance in

two ways. Firstly, firm exposure to business risk is a direct result of previous

Investment and Financing decisions. Secondly, both disciplines share the goal of

creating, or enhancing, firm value. All large corporations have risk smanagement

teams, and small firms practice informal, if not formal, risk management.

Derivatives are the instruments most commonly used in Financial risk

management. Because unique derivative contracts tend to be costly to create and

monitor, the most cost-effective financial risk management methods usually

involve derivatives that trade on well-established financial markets. These

standard derivative instruments include options, futures contracts, forward

contracts, and swaps.

The most important element of managing risk is keeping losses small,

which is already part of your trading plan. Never give in to fear or hope when it

comes to keeping losses small.

Risk can be explained as uncertainty and is usually associated with the

unpredictability of an investment performance. All investments are subject to risk,

but some have a greater degree of risk than others. Risk is often viewed as the

potential for an investment to decrease in value.

1.2 What is Risk Management?

Risk is anything that threatens the ability of a nonprofit to accomplish its

mission.



Risk management is a discipline that enables people and organizations to

cope with uncertainty by taking steps to protect its vital assets and resources.

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6 SPOT EXCHANGE MARKET
Risk Management in Forex MarketsRisk Management in Forex Markets

6.1 Introduction

Spot transactions in the foreign exchange market are increasing in volume.

These transactions are primarily in forms of buying/ selling of currency notes,

encashment of traveler’s cheques and transfers through banking channels. The last

category accounts for the majority of transactions. It is estimated that about 90 per

cent of spot transactions are carried out exclusively for banks. The rest are meant

for covering the orders of the clients of banks, which are essentially enterprises.

The Spot market is the one in which the exchange of currencies takes place

within 48 hours. This market functions continuously, round the clock. Thus, a spot

transaction effected on Monday will be settled by Wednesday, provided there is no

holiday between Monday and Wednesday. As a matter of fact, certain length of

time is necessary for completing the orders of payment and accounting operations

due to time differences between different time zones across the globe.

6.2 Magnitude of Spot Market

According to a Bank of International Settlements (BIS) estimate, the daily

volume of spot exchange transactions is about 50 per cent of the total transactions

of exchange markets. London market is the first market of the world not only in

terms of the volume but also in terms of diversity of currencies traded. While

London market trades a large number of currencies, the New York market trades,

by and large, Dollar (75 per cent of the total), Deutschmark, Yen, Pound Sterling

and Swiss Franc only. Amongst the recent changes observed on the exchange

markets, it is noted that there is a relative decline in operations involving dollar

while there is an increase in the operations involving Deutschmark. Besides,

deregulation of markets has accelerated the process of international transactions.

6.3 Quotations on Spot Exchange Market

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Risk Management in Forex MarketsRisk Management in Forex Markets

The exchange rate is the price of one currency expressed in another

currency. Each quotation, naturally, involves two currencies. There is always one

rate for buying (bid rate) and another for selling (ask or offered rate) for a

currency. Unlike the markets of other commodities, this is a unique feature of

exchange markets. The bid rate is the rate at which the quoting bank is ready to

buy a currency. Selling rate is the rate at which it is ready to sell a currency. The

bank is a market maker. It should be noted that when the bank sells dollars against

rupees, one can say that it buys rupees against dollars. In order to separate buying

and selling rates, a small dash or an oblique line is drawn between the two. Often,

only two or four digits are written after the dash indicating a fractional amount by

which the selling rate is different from buying rate. For example, if dollar is quoted

as Rs 42.3004-3120, it means that the bank is ready to buy dollar at Rs 42.3004

and ready to sell dollar at Rs 42.3120. Dealers do not quote the entire figure. They

may quote, for example, 3004-3120 for dollar. It is these four digits that vary the

most during the day. Here, the operators understand because of their experience

that a quote of 3004-3120 means Rs 42.3004-42.3120.

The banks buy at a rate lower than that at which they sell a currency. The

difference between the two constitutes the profit made by the bank. When an

enterprise or client wants to buy a currency from the bank, it buys at the selling

rate of the bank. Likewise, when the enterprise wants to sell a currency to the

bank, it sells at the buying rate of the bank. Table gives typical quotations. As is

clear from the rates in the table, the buying rate is lower than selling rate.

TABLE: Currency Quotations given by a Bank

CURRENC
Y

BUYING
RATE

SELLING
RATE

Rupee/US $ 42.3004 42.3120

Rupee /DM 22.2025 22.2080

The prices, as we see quoted in the newspapers, are for the interbank

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CONCLUSION

Risk Management in Forex MarketsRisk Management in Forex Markets

In a universe with a single currency, there would be no foreign exchange

market, no foreign exchange rates, and no foreign exchange. But in our world of

mainly national currencies, the foreign exchange market plays the indispensable

role of providing the essential machinery for making payments across borders,

transferring funds and purchasing power from one currency to another, and

determining that singularly important price, the exchange rate. Over the past

twenty-five years, the way the market has performed those tasks has changed

enormously.

Foreign exchange market plays a vital role in integrating the global

economy. It is a 24-hour in over the counter market –made up of many different

types of players each with it set of rules, practice & disciplines. Nevertheless the

market operates on professional bases & this professionalism is held together by

the integrity of the players.

The Indian foreign exchange market is no expectation to this international

market requirement. With the liberalization, privatization & globalization initatited

in India. Indian foreign exchange markets have been reasonably liberated to play

there efficiently. However much more need to be done to make over market

vibrant, deep in liquid.

Derivative instrument are very useful in managing risk. By themselves,

they do not have any value nut when added to the underline exposure, they provide

excellent hedging mechanism. Some of the popular derivate instruments are

forward contract, option contract, swap, future contract & forward rate agreement.

However, they have to be handle very carefully otherwise they may throw open

more risk then in originally envisaged.

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