Foreign Exchange Rate Risk Managment
Foreign exchange rate risk
Foreign exchange rate risk is the potential impact of adverse currency rate movements on earnings and economic value. This involves settlement risk which arises when a banking institution incurs financial loss due to foreign exchange positions taken in both the trading and banking books.
Foreign exchange positions and subsequent risk arise from the following activities:
● trading in foreign currencies through spot, forward and option transactions as a market maker or position taker, including the unhedged positions arising from customer-driven foreign exchange transactions;
● holding foreign currency positions in the banking book (e.g. in the form of loans, bonds, deposits or cross-border investments); or ●engaging in derivative transactions (e.g. structured notes, synthetic investments and structured deposits) that are denominated in foreign currency for trading or hedging purposes.
Foreign exchange risk identification and measurement:
Foreign exchange rate risk exposures fall into the following structural and trading categories:
● Translation exposure: which arises from accounting based changes in consolidated financial statements caused by changes in exchange rates;
● Transaction exposure: which occurs when exchange rates change between the time that an obligation is incurred and the time it is settled, thus affecting actual cash flows; and
Banking institutions should conduct stress tests on their foreign currency positions. The stress tests for exchange rate risk assess the impact of changes in exchange rates on the profitability and economic value of a banking institution’s equity. The effects of significant exchange rate movements, including sharp reductions in liquidity, of individual currencies should be considered when setting stress scenarios.
To understand translation and transactional risk better an emphasis has been made on SBM dealings. SBM exercises strict control over its
Foreign exchange rate risk is the potential impact of adverse currency rate movements on earnings and economic value. This involves settlement risk which arises when a banking institution incurs financial loss due to foreign exchange positions taken in both the trading and banking books.
Foreign exchange positions and subsequent risk arise from the following activities:
● trading in foreign currencies through spot, forward and option transactions as a market maker or position taker, including the unhedged positions arising from customer-driven foreign exchange transactions;
● holding foreign currency positions in the banking book (e.g. in the form of loans, bonds, deposits or cross-border investments); or ●engaging in derivative transactions (e.g. structured notes, synthetic investments and structured deposits) that are denominated in foreign currency for trading or hedging purposes.
Foreign exchange risk identification and measurement:
Foreign exchange rate risk exposures fall into the following structural and trading categories:
● Translation exposure: which arises from accounting based changes in consolidated financial statements caused by changes in exchange rates;
● Transaction exposure: which occurs when exchange rates change between the time that an obligation is incurred and the time it is settled, thus affecting actual cash flows; and
Banking institutions should conduct stress tests on their foreign currency positions. The stress tests for exchange rate risk assess the impact of changes in exchange rates on the profitability and economic value of a banking institution’s equity. The effects of significant exchange rate movements, including sharp reductions in liquidity, of individual currencies should be considered when setting stress scenarios.
To understand translation and transactional risk better an emphasis has been made on SBM dealings. SBM exercises strict control over its