Forex Trading

Currency options provide corporate treasurer another tool for hedging foreign exchange risks arising out of firms operations. Unlike forward contract, options allow the hedger to gain from favorable exchange rate movements, while been unprotected from unfavorable movements. However forward contracts are costless while options involve up front premium cost. Examples are:

a) Hedging a Foreign Currency with calls.

In late February an American importer anticipates a yen payment of JYP 100 million to a Japanese supplier sometime late in May. The current USD/JYP spot is 0.007739 (which implies a JYP/USD rate of 129.22.). A June yen call option on the PHLX, with strike price of $0.0078 per yen is available for a premium of 0.0108 cents per yen or $0.000108 per yen.… Read the rest

A firm may be able to reduce or eliminate currency exposure by means of internal and external hedging strategies.

Internal Hedging Strategies

1. Invoicing

A firm may be able to shift the entire risk to another party by invoicing its exports in its home currency and insisting that its imports too be invoiced in its home currency, but in the presence of well functioning forwards markets this will not yield any added benefit compared to a forward hedge. At times, it may diminish the firm’s competitive advantage if it refuses to invoice its cross-border sales in the buyer’s currency.

In the following cases invoicing is used as a means of hedging:

1. Trade between developed countries in manufactured products is generally invoiced in the exporter’s currency.

… Read the rest

Forex Risk Management

The following are the major risks in foreign exchange dealings

• Open Position Risk
• Cash Balance Risk
• Maturity Mismatches Risk
• Credit Risk
• Country Risk
• Overtrading Risk
• Fraud Risk, and
• Operational Risks

Open Position Risk

The open position risk or the position risk refers to the risk of change in exchange rates affecting the overbought or oversold position in foreign currency held by a bank. Hence, this can also be called the rate risk. The risk can be avoided by keeping the position in foreign exchange square. The open position in a foreign currency becomes inevitable for the following reasons:

• The dealing room may not obtain reports of all purchases of foreign currencies made by branches on the same day.

… Read the rest

Exchange Dealings

When the foreign currency denominated assets and liabilities are held, by the banks or the business concern, two types of risks are faced. Firstly, the risk that the exchange rates may vary and the change may affect the cash flows/profits. This is known as exchange risk. Secondly, the interest rate may vary and it may affect the cost of holding the foreign currency assets and liabilities. This is known as interest rate risk. The present section discusses exchange risk management by banks.

Dealing Position

Foreign exchange is such a sensitive commodity and subject to wide fluctuations in price that the bank which deals in it would like to keep the balance always near zero, The bank would endeavour to find a suitable buyer wherever it purchase so as to dispose of the foreign exchange acquired and be free from exchange risk.… Read the rest

The customer may approach the bank for cancellation when the underlying transactions becomes infructrious, or for any other reason he wishes not to execute the forward contract. If the underlying transaction is likely to take place on the day subsequent to the maturity of the forward contract already booked, he may seek extension in the due date of the contract. Such requests for cancellation or extension can be made by the customer on or before the maturity of the forward contract.

Cancellation on Due Date

When the forward purchase contract is cancelled on the due date, it is taken that the bank purchases at the rate originally agreed and sells the same back to the customer at the ready TT rate.… Read the rest