Risk in Forex Operations

 

Risk in Forex Operations:

 

The arena of international trade and foreign exchange operations is also prone to risks, mainly due to the complex nature of transactions, individual characteristic of different currencies as also a vast area of operations.

The foreign exchange operations are plagued with exchange risk, settlement risk, liquidity risk, country risk, sovereign risk, interest rate risk, and operational risk.

1.    Exchange Risk

2.    Settlement Risk

3.    Liquidity Risk

4.    Country Risk/Sovereign Risk

5.    Interest Rate Risk

6.    Operation Risk

7.    Legal Risk

The risks need to be accepted and managed effectively and efficiently to minimize the adverse effect and maximize the profit of the organizations.

 

Derivatives: Derivative are such instruments offer a vehicle to manage risks. Derivatives when added to the exposure will neutralize or alter to acceptable levels, the uncertainty profile of the exposure. The values of these financial instruments are derived from the values of the underlying exposures.

 

Some of the popular derivative instruments in foreign exchange market are, forward contracts, options, swaps, forward rate agreement and futures.

 

Forward Contract: It is a binding contract for purchase/sale at a future date.

Swap: It is an exchange of specific streams of payments over an agreed period of time.

Forward rate: Value to be settled beyond spot date.

Options: A foreign exchange option is a contract for future delivery of currency in exchange for another, where the holder of the option has the right, without an obligation, to buy (or sell) the currency at an agreed price, the strike or exercise price, on a specified future date.

Futures: Futures are forward contracts with a standard size, standard maturity date governed by a set of guidelines stipulated by the exchange concerned for settlement and payments.

 

Foreign Exchange Market and its Regulators:

 

International banking and trade involve transactions between two countries, currencies and as such are controlled, supervised, regulated and supported by the central bank of country, while assisted and supported by various other agencies like EXIM Bank, Insurance companies, ECGC, FEDAI etc.