Study Guides (248,605)
Canada (121,634)
Finance (316)
FIN 701 (17)

Chapter 14 Foreign Exchange Risk.docx

3 Pages

Course Code
FIN 701
Patricia Mc Graw

This preview shows page 1. Sign up to view the full 3 pages of the document.
FIN701 Financial Institutions Management CHAPTER 14 Foreign Exchange Risk FOREIGN EXCHANGE RATES AND TRANSACTIONS Foreign Exchange Rates  Foreign exchange rate is the price at which one currency can be exchanged for another currency  Foreign exchange rates listed in two ways 1. Direct quote: Canadian dollars received for one unit of the foreign currency exchanged 2. Indirect quote: foreign currency received for each Canadian dollar exchanged Foreign Exchange Transactions  Two basic types of foreign exchange rates and foreign exchange transactions: 1. Spot foreign exchange transaction – foreign exchange transaction involving the immediate exchange of currencies at the current (or spot) exchange rate  Appreciation of country’s currency (or rise in its value relative to another currencies) means country’s goods are more expensive for foreign buyers and that foreign goods are cheaper for foreign sellers  Deprecation of country’s currency (or fall in its value relative to another currencies) means country’s goods become cheaper for foreign buyers and that foreign goods become more expensive for foreign sellers 2. Forward foreign exchange transaction – exchange of currencies at a specified exchange rate (or forward exchange rate) at some specified date in the future SOURCES OF FOREIGN EXCHANGE RISK EXPOSURE  Big Six banks take significant positions in foreign currency assets and liabilities  Spot foreign exchange – foreign currency traded for immediate delivery  Forward foreign exchange – foreign currency traded for future delivery  Net exposure – degree to which an FI is net long (positive) or net short (negative) in a given currency o Positive net exposure position implies FI is overall net long in a currency (i.e. FI bought more foreign currency than it has sold) and faces the risk that the foreign currency will fall in value against the dollar o Negative net exposure position implies FI is net short in a foreign currency (i.e. FI sold more foreign currency than it has purchased) and faces risk that foreign currency could rise in value against the dollar ( ) ( )  Absolute size of FX exposure are smaller for three reasons: smaller asset sizes, prudent person concerns, and regulations  Carry trades – purchase by an investor of a currency in a country with high interest rates funded by borrowing in a currency with low interest rates  Momentum trading – taking large position in a currency (or other financial asset) in order to take advantage of long-term increases in exchange rates  Foreign currency transactions involving hedge funds, mutual funds, pension funds, and insurance companies more than doubled as these types of FIs shifted to portfolios that were more diversified Foreign Exchange Rate Volatility and FX Exposure  Measure potential size of FX exposure by analyzing asset, liability, and currency trading mismatches on balance sheet and underlying volatility of exchange rate movements o The larger the FI’s net exposure in foreign currency and the larger the foreign currency’s exchange rate volatility, the larger the potential dollar loss or gain to FI’s earnings o Volatility reflects fluctuations in demand for and supply of country’s currency [ ] ( ) FOREIGN CURENCY TRADING  Foreign exchange currency has been called the fairest market in the world because of immense volume and the fact that no single institution can control market’s direction FIN701 Financial Institutions Management  Fluctuations in exchange rates where FX trading risk exposure continues into the night even when other FI operations are closed adds risk from holding misma
More Less
Unlock Document

Only page 1 are available for preview. Some parts have been intentionally blurred.

Unlock Document
You're Reading a Preview

Unlock to view full version

Unlock Document

Log In


Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.