mmt of foreign exchange

8/7/2019 mmt of foreign exchange

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MANAGEMENT OF FOREIGNEXCHANGE

EXPOSURE AND RISK

PRESENTED BY:PARUL ASTHANA

MBA IB- IV


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FOREIGN EXCHANGE EXPOSUREAccording to MICHAEL ADLER AND

BERNARD DUMAS

The sensitivity of changes in the realdomestic currency value of assets,liabilities or operating incomes tounanticipated changes in exchangerates


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SENSITIVITY CAN BE EXPRESSED

AS:RV = + (S) +

Here,

RV = Change in the real domestic value of a particular itemS = unanticipated changes in exchange rate between

domestic and foreign currency

= Slope of the regression line

= Constant

= Random error


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FOREIGN EXCHANGE RISKDEF :

FOREIGN RISK can be defined as the

variance of the domestic currencyvalue of assets, liabilities or operatingincomes that is attributable tounanticipated changes in foreign

exchange rates.


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FOREIGN EXCHANGE RISKSymbolically :

Var(RV) = 2Var(S)

Here,Var(RV) = variance of the change in value of a businessitem caused by unanticipated changes in foreignexchange rates

= regression coefficient which describes the systematicrelation between (RV)

And (S)

Var(S)= variance of unanticipated changes in the foreignexchange rate


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TYPES OF EXPOSURE

Foreign ExchangeExposure

EconomicExposure

Translation/AccountingExposure

TransactionExposure

Operating Exposure


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ECONOMIC EXPOSUREIt can be classified as follows:

1. Transaction Exposure

2. Operating exposure


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TRANSACTION EXPOSURE Refers to the potential changes in

value of contractual cash flow thatarises due to unexpected changes inthe foreign exchange rate.

A firm is exposed to transactionexposure when it has monetary itemswhose values are contractually fixedin foreign currencies and dontchange with the exchange rates.


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MANAGING TRANSACTION

EXPOSUREManaging

TransactionExposure

HedgingTechniques

OperationalTechniques

Forwardsand

Futures

Money markethedge

options SwapsNetting

&Offsetting

Currency ofInvoicing

Leading&

Lagging


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Hedging with Forwards and Futures A forward contract is a legally enforceable

agreement to buy or sell a certain amountof foreign currency on a specified date at

an exchange rate fixed at the time ofentering the contract

A firm may hedge their transactionexposure by buying or selling foreigncurrency forward and thereby avoidingfluctuations in the home currency value ofthe foreign currency denominated fixedfuture cash flow.


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MONEY MARKET HEDGING Money market hedging involves

simultaneously borrowing and lending orinvesting in a money market with an aim to

avoid or reduce foreign exchange exposurewith regard to exposure or payables.

A firm that wants to hedge foreignexchange exposures on receivables(payables) may borrow (lend) foreigncurrency in the money market, so that itsassets and liabilities in the same currencywill match.


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STEPS INVOLVED IN MONEY

MARKET HEDGING Borrow in the foreign currency in which the

receivables are denominated at theprevailing interest rates.

Convert the borrowed currency at the spotbid rates

Invest that amount at the prevailinginterest rates for the period of thereceivables.

Repay the foreign currency loan with theamount realized through receivables. Realize the maturity value of the

investment.


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HEDGING WITH OPTIONSA currency optionis a contract thatgives the buyer the

right, but not theobligation, to buyor sell a specifiedcurrency at a

specified exchangerate in the future

OPTIONS

PUT OPTION CALL OPTION


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CALL & PUT OPTION CALL OPTION

A call option gives a opinion holder a rightto buy a specific quantity of foreign

currency from the option seller at a fixedrate of exchange on or before theexpiration date.

PUT OPTIONA put option gives the option holder a right

to sell a specified quantity of foreigncurrency to the option seller at a fixed rateof exchange on or before the expirationdate


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SWAPS A swap is an agreement between two

parties to exchange a cash flow in

one currency against a cash flow inanother currency according to the pre determined terms and conditions.

mmt of foreign exchange

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