Term
| How can a bank's actual exposure to any given currency be measured? |
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Definition
by the net position exposure
This is the extent which which a bank is net long (positive) or net short (negative) in a given currency.
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Term
| Formula for working out a bank's net euro exposure? |
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Definition
net EUR exposure = (EUR assets - EUR liabilities) + (EUR bought) - (EUR sold)
can be expressed as:
net EUR exposure = net EUR assets + net EUR bought |
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Term
What does a positive net exposure position mean?
If we have a positive net exposure position, what foreign exchange risk are we concerned about? |
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Definition
positive net exposure position means we are net long in a currency.
hold more assets than liabilities in a given currency.
If positive net exposure, the institution faces the risk that the foreign currency will fall in value against the domestic currency (assets will then be worth less in the domestic currency) |
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Term
What's another name for net short in a currency?
If this is the case, what is the risk? |
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Definition
net short in a currency = negative net exposure position in a currency
risk is that the the foreign currency will rise in value against the domestic currency (liabilities will then be worth more in the domestic currency) |
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Term
| List and describe the different types of foreign exchange trading activities financial institutions take part in: |
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Definition
- Enabling customers to participate in international commercial business transactions
- Enabling customers to take positions in real or financial foreign investments
- Offsetting exposure in a given currency for hedging purposes
- Speculating on foreign currencies in search of profit by forecasting and/or anticipating futures FX rate movements
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Term
| What are the two principal methods available to control the scale of FX exposure? |
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Definition
- on balance sheet hedging: achieved when a financial institution has a matched maturity and currency foreign asset-liability book
- off balance sheet hedging: remain unhedged in the balance sheet but hedge off-balance by taking a position in the forward market. |
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Term
| When is on-balance sheet hedging achieved? |
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Definition
| - when a financial institution has a matched maturity and currency foreign asset-liability book |
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Term
| Describe Interest Rate Parity: |
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Definition
IRP states that a firm should not be able to make excess profits from foreign investments (i.e. a higher domestic currency return from lending in a foreign corrency and locking in the forward rate of return
(from wiki) the spot price and the forward or futures price of a currency incorporate any interest rate differentials between the two currencies.
The equation:
forward = spot * [(1 + domestic currency rate) / (1 + foreign currency rate)]T
with continuous compounding:
forward = spot * e(rdc-rfc)T |
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