EXCHANGE RATE RISK MANAGEMENT

Exchange Rate Risk Management



Exchange Rate Risk Management

Net Exposure of Foreign Currency in Dollars

Currency

Net Inflow or Outflow

Spot Exchange Rate

Net Inflow or Outflow

Measured in Dollars

Canadian dollars (C $)

C$30,000,000 Inflow

$ 0.90

$27,000,000 Inflow

New Zealand dollars (NZ $)

NZ$4,000,000 Inflow

$ 0.60

$ 2,400,000 Inflow

Mexican pesos (MXP)

MXP1,000,000 Inflow

$ 0.18

$ 180,000 Inflow

Singapore dollars (S $)

S$4,000,000 Outflow

$ 0.65

$ 2,600,000 Outflow

Offsetting Exchange Rate Effects Due to Exchange Rate Movements

Currency

Net Inflow or Outflow

Rate

Change in Cash Flow

Canadian dollars (C $)

30,000,000

0.9

27000000

New Zealand dollars (NZ $)

4,000,000

0.59

2360000

Mexican pesos (MXP)

1,000,000

0.15

150000

Singapore dollars (S $)

4,000,000

0.64

2560000

The exchange rate effects from exchange movements vary according to change in currency. The exchange rate risk is defined as the probability of loss from fluctuations in exchange rates of the currencies in which they are denominated assets, liabilities and off balance sheet entity. The exchange rate risk is a market risk that affects both the banking book and the trading book of a financial institution.

Exchange rate risk is the uncertainty of the value of a currency that occurs when one currency is converted into another. This source of risk applies only if the investor acquires foreign assets denominated in a foreign currency. There are two approaches to calculate the market risk from exchange rate that includes standard method and internal models. The standard method assigns equal treatment to all foreign currencies under the assumption that the effect of fluctuations between currencies is proportional. Therefore, the calculation of the estimate of exchange rate risk comes from the sum of the highest overall net position (short or long) plus the amount of gold regardless of the sign (Bauwens, Rime and Sucarrat, 2006).

The internal models quantify the market risk models based on Value at risk. Value at risk summarizes the loss that could occur in a defined time horizon with a given confidence interval. The Basel Committee suggests using a time horizon of ...