Forex Exchange and Risk Management 1

FOREX EXCHANGE
RISK MANAGEMENT
BY:
DELA CRUZ BA.

DELA CRUZ R.
SILVESTRE NJ.
SILVESTRE JC.
TECSON AL.
 Before delving into foreign exchange risk, it
is useful to understand the terminology
FOREIGN used in the foreign exchange quotation
EXCHANGE process. When comparing the price of one
QUOTE currency to another, the Base Currency is
the unit of currency that does not fluctuate
TERMINOLOGY in amount, while the quoted currency or
price currency does fluctuate.
 Is determining the extent of a company’s
currency risk that can be a frustrating
DATA exercise for the foreign exchange specialist,
COLLECTION who is often at the receiving end of the
flood of disorganized information arriving
FOR FOREIGN from the accounting, budgeting, tax, and
EXCHANGE treasury departments.
RISK  A large from with an enterprise resources
MANAGEMENT planning system can automatically
accumulate its exiting net currency
exposures from the ERP system.
There are a variety of foreign exchange
hedging strategies noted in this section. The
FOREIGN main strategy groupings are:
EXCHANGE To not hedge the exposure
HEDGING To hedge the exposure through
business practices
STRATEGIES
To hedge the exposure with a
derivative
Not hedging the exposure is the
ACCEPT simplest strategy of all. A company
can accept the foreign exchange risk,
THE RISK and record any gains or losses on
changes in the spot rate as they occur.
INSIST ON HOME CURRENCY
SEVEN PAYMENTS
STRATEGIES CURRENCY SURCHARGES
OF INTERNAL GET PAID ON TIME
BUSINESS
FOREIGN CURRENCY LOANS
PRACTICE
SOURCING CHANGES
THAT
REDUCE FOREIGN CURRENCY ACCOUNTS
CURRENCY UNILATERAL, BILATERAL AND
MULTILATERAL NETTING
EXPOSURE ARRANGEMENT
It is in which is the most commonly
FORWARD used foreign exchange hedge, a
company agrees to purchase a fixed
EXCHANGE amount of foreign currency on a
CONTRACTS specific date, and at a predetermined
rate
THE INTEREST
RATE
DIFFERENTIAL 1. The currency of the country having a
higher interest rate trades at a discount.
IS CALCULATED
IN 2. The currency of the country having a
ACCORDANCE lower interest rate trades at a premium.
WITH THESE
TWO RULES
 It is the same as forward exchange
contracts, except that is trades on an
exchange.
CURRENCY  These contracts are normally handled
FUTURES through a broker, who charges a
commission.
 Since currency futures have standard sizes
and expiry date
 It requires the payment of a premium in exchange
for a right to use one currency to buy another
currency at a specified price on or before a
specified date.
CURRENCY  An option is easier to manage than a forward

exchange contract because a company can
OPTIONS choose not to exercise its option to sell currency if
a customer does not pay it.
 Are especially useful for those companies
interested in bidding on contracts that will be paid
in a foreign currency
 Is a spot transaction on the over-the-counter
market that is executed all the same time as a
forward transaction, with currencies being
exchanged at both the spot date and the forward
CURRENCY date.
SWAPS  Is useful when a company forecasts a short-term
liquidity shortfall in a specific currency, and has
sufficient funds in a different currency to effect a
swap into the currency where funds are needed.
 The use of a price- or rate-correlated financial
instrument to hedge a particular risk when a
PROXY direct hedge for that risk is not available.
HEDGING Common proxy hedges are the use of one
currency which moves in concert with another
to hedge the risk in the other currency.
 There are complex hedging rules that permit a
company to elect to obtain special accounting
treatment relative to foreign currency risks.
HEDGE  In the instance of foreign currency hedge,
ACCOUNTING companies must exclude fro their assessments of
hedge effectiveness the portions of the fair value of
forward contracts attribute to spot-forward
differences.
Authorized Controls
Define Dealing Responsibilities
Issue an Update Signatory List to
FOREIGN Counterparties at least once a year
CURRENCY Centralize Foreign Exchange Trading
Operations
HEDGE
Contractual Controls
CONTROLS Verify Contract terms and Signatory
Confirm all hedging Transactions
Use Standardized Master Agreements
Hedge Accounting Controls
Include in the hedging procedure a
FOREIGN requirement for full documentation of each
Hedge
CURRENCY General Risks Assessment Controls
HEDGE Determine Counterparty credit-worthiness
CONTROLS Full-risk Modeling
Audit Spreadsheet calculations and
contents
Accounting Consistency Policies
The determination of hedge effectiveness
shall always use the same method for
similar types of hedges
FOREIGN  Deal Boundaries
EXCAHNGE Review benchmark Hedge ratio
HEDGE Authorization Policies

Authorization to deal in foreign exchange
POLICIES hedging transactions shall be issued solely
by the board of directors
All sales contracts not denominated in US
Dollars must be approve in advance by the
treasury department
RECORD KEEPING
FOR FOREIGN
EXCHANGE HEDGING
ACTIVITIES
1. Purpose and scope
2. Procedures
2.1 Set up hedging transaction (Asst. Treasurer)
2.2 Confirm the Hedge (Treasury Clerk) FOREIGN
2.3 Review the Contract Legality (Legal Staff) EXCHANGE
2.4 Account for the Hedge (Asst. Controller) HEDGE
2.5 Reconcile the Hedge (Asst. Controller) PROCEDURE
2.6 Report on the result of the Hedge (Asst. Controller)

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FOREX EXCHANGE

DELA CRUZ BA.

CURRENCY  An option is easier to manage than a forward

HEDGE Authorization Policies

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