Summary Currency Risk
AVANS UNIVERSITY OF APPLIED SCIENCES
SIMONE SNEPVANGERS
,Table of Contents
Chapter 6 The foreign exchange market......................................................................................................2
Chapter 7 International Parity Conditions....................................................................................................4
Chapter 8 Foreign Currency Derivatives and Swaps.....................................................................................9
Chapter 10 Transaction and Translation Exposure.....................................................................................11
Chapter 11 Operating Exposure.................................................................................................................14
1
, Chapter 6 The foreign exchange market
The foreign exchange market provides the physical and institutional structure through which the money
of one country is exchanged for that of another country.
- Foreign exchange = the money of a foreign country
- Foreign exchange transaction = an agreement between a buyer and seller that a fixed amount of
one currency will be delivered for some other currency at a specified rate
Geographical extent of the foreign exchange market = 24h/7. In the entire world, markets open and
close at different times. Which makes it difficult for different currencies, however, with the current
technologies, it is all internet-based.
Functions of the foreign market
- Transfer of purchasing power is necessary because international trade and capital transactions
normally involve parties living in countries with different national currencies
- Inventory in transit must be financed the movement of goods between countries take time
- Foreign exchange market provides ‘hedging’ facilities for transferring foreign exchange risk to
someone else more willing to carry risk
Market participants (two tiers)
- The interbank/wholesale market
- Client/retail market
There are 5 broad categories of participants within these two tiers
1. Bank and nonbank foreign exchange dealers
2. Individuals and firms conducting commercial or investment transactions
3. Speculators and arbitragers
4. Central banks and treasuries
5. Foreign exchange brokers
Transactions in the interbank market
- Spot transactions = the purchase of foreign exchange, with delivery and payment between banks
to take place (normally on the second business day)
- Forward transactions = requires delivery at a future value date of a specified amount of one
currency for a specified amount of another currency
- Swap transactions = the simultaneous purchase and sale of a given amount of foreign exchange
for two different value dates
Forward-Forward Swaps
Nondeliverable Forwards (NFDs)
Currency composition = all currencies are traded against some other currency, all percentages shown are
currency versus another
Foreign exchange rate = the price of one currency expressed in terms of another currency
Foreign exchange quote = a statement of willingness to buy or sell at an announced rate
2
AVANS UNIVERSITY OF APPLIED SCIENCES
SIMONE SNEPVANGERS
,Table of Contents
Chapter 6 The foreign exchange market......................................................................................................2
Chapter 7 International Parity Conditions....................................................................................................4
Chapter 8 Foreign Currency Derivatives and Swaps.....................................................................................9
Chapter 10 Transaction and Translation Exposure.....................................................................................11
Chapter 11 Operating Exposure.................................................................................................................14
1
, Chapter 6 The foreign exchange market
The foreign exchange market provides the physical and institutional structure through which the money
of one country is exchanged for that of another country.
- Foreign exchange = the money of a foreign country
- Foreign exchange transaction = an agreement between a buyer and seller that a fixed amount of
one currency will be delivered for some other currency at a specified rate
Geographical extent of the foreign exchange market = 24h/7. In the entire world, markets open and
close at different times. Which makes it difficult for different currencies, however, with the current
technologies, it is all internet-based.
Functions of the foreign market
- Transfer of purchasing power is necessary because international trade and capital transactions
normally involve parties living in countries with different national currencies
- Inventory in transit must be financed the movement of goods between countries take time
- Foreign exchange market provides ‘hedging’ facilities for transferring foreign exchange risk to
someone else more willing to carry risk
Market participants (two tiers)
- The interbank/wholesale market
- Client/retail market
There are 5 broad categories of participants within these two tiers
1. Bank and nonbank foreign exchange dealers
2. Individuals and firms conducting commercial or investment transactions
3. Speculators and arbitragers
4. Central banks and treasuries
5. Foreign exchange brokers
Transactions in the interbank market
- Spot transactions = the purchase of foreign exchange, with delivery and payment between banks
to take place (normally on the second business day)
- Forward transactions = requires delivery at a future value date of a specified amount of one
currency for a specified amount of another currency
- Swap transactions = the simultaneous purchase and sale of a given amount of foreign exchange
for two different value dates
Forward-Forward Swaps
Nondeliverable Forwards (NFDs)
Currency composition = all currencies are traded against some other currency, all percentages shown are
currency versus another
Foreign exchange rate = the price of one currency expressed in terms of another currency
Foreign exchange quote = a statement of willingness to buy or sell at an announced rate
2
