FOREIGN EXCHANGE RISK

AND ITS
MANAGEMENT
 • Have a look at the investment portfolios of the
world’ s most successful investors like Warren
Buffet, Benjamin Graham, George Soros, Peter
Lynch, Michael Bloomberg etc. They never
dependent on one investment class. Their
investments range from stocks & commodities to
currencies & bonds.

• People simply ignore the world’s most liquid &

lucrative market the Forex market that these
people have relied upon.

the Man Who Broke the Bank of England" Successful wall street Worked with Salomon
after he made a reported $1 billion during Investor, one of the brothers, Merrill lynch
the best & now mayor of NEW YORK
1992 Black Wednesday UK currency crises Stock pickers in city.
correctly anticipated that the world , heart of
British government would have to devalue Fidelity.
the pound sterling
 Why better
• World’s largest fastest growing &
most liquid market (daily turnover
exceeding US$3 trillion).

• 24 hrs trading. Flexibility to work as

per your leisure.

• Highest profitability if you trade well.

• Less volatile as compared to stocks.

• World’s most advanced trading

platforms.- Meta Trader 4.
 MEANING
• This risk usually affects businesses that export and/or import,
but it can also affect investors making international
investments.

• The risk of an investment's value changing due to changes in

currency exchange rates is FOREIGN EXCHANGE RISKS.

• For example, if money must be converted to another currency

to make a certain investment, then any changes in the
currency exchange rate will cause that investment's value to
either decrease or increase when the investment is sold and
converted back into the original currency.
 5 MAJOR RISKS IN FOREX
• Broker Risk: There is always a small chance that your broker will go
bankrupt or otherwise meet their demise.

• Tech Risks: There's no doubt that computer, power or Internet issues

could seriously dampen your results in the markets.

• Market Risk: This is the only type of foreign exchange risk management

most traders think about -- how daily fluctuations of currency values
affect our positions.

• Economic and Political Risks: Political policy changes, major economic

emergencies and governing authority intervention can all have an impact
on a country's currency value.

• Country Specific Risk:  the risk of a country defaulting on its financial

commitments.
HOW DEAL WITH FOREX RISK
?
• HEDGING
– Hedging enables you to manage risk and reduce potential
risk.
– Many people think of hedging as buying an insurance policy
for their currency position, and it acts in much the same
way. By using investment instruments known as derivatives,
Forex traders can rest easy knowing that any losses will be
covered by the backup plan.

– If you don't hedge and assume that the foreign currency rate
will always stay the same, then it can prove to be costly.

– There are a number of products for hedging Forex risk,

which involve buying foreign currency now at known
exchange rates or gaining the right to buy or sell foreign
currency at a later date but at a fixed exchange rate.
 STOP LOSS ORDERS
• Stop loss in currency is the most common way to
minimize risk in Forex trading.

• A stop-loss order contains instructions to exit your

position if the price reaches a certain point. When you
place a stop order, you need to set an exit point, to
happen if the trade losses a specific value..
 Example
• For example, if you bought EUR/USD at
1.7480 you could enter a stop-loss order to
sell at, say, 1.7460. This would effectively
limit your potential loss on the position to
20 pips if the price fell.
• The "trailing stop" is used to lock in
profits. For example, if you bought
EUR/USD at 1.7480 and the price has risen
to 1.7520, giving you a profit of 40 pips,
you may want to lock in a certain amount
of that profit in case the price falls back
down.
• You would simply place a stop order to sell
at, say, 1.7510. This assures that if the price
does drop, your position will be closed
automatically with a profit of 30 pips.
• If the price keeps increasing and the
position becomes even more profitable, the
trader may move his or her trailing stop up
yet again, thereby "locking in" more profits.
HEDGING PRODUCTS

 Currency Forward Contracts

 Futures Contract

 Currency Options

 Currency Swaps
CURRENCY FORWARD CONTRACT
 An agreement between two parties to exchange a certain amount
in currencies at a certain rate at a certain time.

 When a forward contract of any sort is made, terms are negotiated

directly between the parties, unlike a futures contract,
which trades on an exchange.

 A forward contract in the Forex market that locks in the price at

which an entity can buy or sell a currency on a future date. Also
known as an outright forward currency transaction, forward outright
or FX forward.

 Thus, in a currency forward, each party believes that the

prevailing exchange rate will move in a direction favorable to
him/her by the expiry of the contract.
FUTURES CONTRACT
 Currency futures are legally binding contracts between buyers and
sellers to buy or sell a specific sum of currency in exchange for
another at a specified exchange rate.

 Delivery of the same is meant to take place on a specific future date.

 Currency futures are also known as Forex futures or exchange

futures.

 Currency futures are traded in specialized futures exchanges.

 Currency Futures as Standardized Contracts. The futures exchange

sets the contract specifications.
CURRENCY OPTIONS
 Currency options are derivatives contracts in which foreign currency is the
underlying asset. Currency options are also known as Forex options or FX
options. The contract is between a buyer and a seller and gives the buyer
the right (but not the obligation) to buy or sell the underlying foreign
currency at a specified price on an agreed upon date in the future.

 There are two types of options:

 Call options give the holder the right to buy a given amount of a currency at
the strike price.
 Put options give the holder the right to sell a given amount of currency at the
strike price.

 For exercising the right to trade the underlying asset, the seller of the
option is paid a price, known as premium. The price that is specified for
either buying or selling at the future date is known as the strike price.
CURRENCY SWAPS
 A currency swap is an agreement between two parties to exchange the principal
loan amount and interest applicable on it in one currency with the principal and
interest payments on an equal loan in another currency.

 These contracts are valid for a specific period, which could range up to ten years,
and are typically used to exchange fixed-rate interest payments for floating-rate
payments on dates specified by the two parties.

 Since the exchange of payment takes place in two different currencies, the

prevailing spot rate is used to calculate the payment amount. This financial
instrument is used to hedge interest rate risks.

 For instance, a US-based company needing to borrow Swiss Francs, and a Swiss-
based company needing to borrow a similar present value in US Dollars, could both
reduce their exposure to exchange rate fluctuations by arranging any one of the
following: he companies could borrow in their own domestic currencies (and may
well each have comparative advantage when doing so), and then get the principal in
the currency they desire with a principal-only swap.