Please enable JavaScript.
Coggle requires JavaScript to display documents.
FOREIGN EXCHANGE RISK MANAGEMENT - Coggle Diagram
- FOREIGN EXCHANGE RISK MANAGEMENT
Types of risk
Translation (or accounting) risk - exchange profits/losses that result from converting foreign currency balances for the purposes of preparing the accounts.
Economic risk - PV of future cash flows due to unexpected movements in foreign exchange rates. E.g. raw material imports increasing in cost
Transaction risk - transaction in a foreign currency at one exchange rate is settled at another rate (because the rate has changed).
Hedging 4
-
Right to convert on last day of March, June, Sept & Dec (only 4 dates a year)
Gambling on exchange rates - I don’t have money to buy currency now. Will need to pay a deposit. Manager can use these to cancel’ (or hedge against) the risk of a commercial transaction
- If price will go up: Ring the dealer - BUY 1,000 futures today at $1.50 & SELL 1,000 futures next week at 1.60 (10 cents profit)
- If price will go down – SELL 1,000 futures today at 1.50 (even if I have nothing to sell) & BUY 1,000 futures at $1.40 (10cents profit)
- Will settle at the end – receive money from dealer (together with deposit)/ pay money to dealer
-
- Futures price on any day is not the same as the spot exchange rate on that date
- Any deal in futures must be in units of a fixed size &
- Movement in the futures price over a period is unlikely to be exactly the same as the movement in the actual exchange rate.
- Movement in the futures price does not exactly equal the movement in the exchange rate & leave us exposed to a little risk (basis risk)
- Buying the contract currency = buy futures (contract currency = currency in which the contract size is quoted).
FOREX
-
-
Although since the market is very competitive virtually no differences exist between one FOREX market to another.
Exchange rates
-
Two prices are quoted -we are buying or selling the currency – the difference is known as the spread $0.06 (bank's profit).
-
-
-
-
-
Ticks
1 tick = 0.0001, which is the smallest possible movement
-
-
Lock in rate
-
-
Effective fixed rate to apply giving net effect on converting the transaction at spot together with gain/loss on futures
-
Hedging 2
Disadvantages
- Contracts are non-reversible; you are legally obliged to settle the transaction
- If the market rate moves favourably, you cannot benefit from the better rate
- Can’t make changes if plans change
Forward contracts - rate quoted today to apply on a fixed future day (quote from bank)
$/£ 1.2845 ± 0.0015 (forward rates are: $/£ 1.2830 – 1.2860)
Advantages:
- Protects businesses and individuals from adverse fluctuations
- Tailored to meet the exact amount, asset type, and delivery datee
- Do not require an upfront payment to lock in the rate
- Eliminates the need to constantly track market fluctuations
Hedging 1
-
-
Leading and lagging - Based in UK & owes $ (if $ will go up - pay early = leading, if $ goes down - delay payment = lagging)
Netting - based in UK - sold to US $100,000 & bought from US $80,000. Use one to pay the other in 1 mth time. Net receipt $20,000 risk/to be converted in £
Matching - in UK - sale to US $100,000p.a.- create expense of $100,000 (deliberately borrowing money in $, buy materials from US, etc
Hedging 3
Money market hedging: converting the foreign currency at the current spot, which therefore makes future changes in the exchange rate irrelevant.
-
-