1 / 19

Overview

Overview. This chapter discusses foreign exchange risk to which FIs are exposed. This issue has become increasingly important for FIs due to hedging needs and speculative positions taken to increase income. With greater integration of global markets, this is an issue for almost all FIs.

kyrie
Télécharger la présentation

Overview

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Overview • This chapter discusses foreign exchange risk to which FIs are exposed. This issue has become increasingly important for FIs due to hedging needs and speculative positions taken to increase income. With greater integration of global markets, this is an issue for almost all FIs.

  2. Background • Globalization of financial markets has increased foreign exposure of most FIs. • FI may have assets or liabilities denominated in foreign currency (in addition to direct positions in foreign currency). • Foreign currency holdings exceed direct portfolio investments.

  3. Sources of FX Risk • Spot positions denominated in foreign currency • Forward positions denominated in foreign currency • Net exposure = (FX assets - FX liab.) + (FX bought - FX sold) • Some decline in FX exposure as a result of the Asian, Russian and Argentinian crises

  4. FX Risk Exposure • FI may have positions in spot and forward markets. • Could match foreign currency assets and liabilities to hedge F/X risk • Must also hedge against foreign interest rate risk (by matching durations, for example)

  5. Trends in FX • Value of foreign positions has increased • Volume of foreign currency trading has decreased • Causes: • Investment bank mergers • Increased trading efficiency through technological innovation • Introduction of the euro

  6. Web Resources • For statistics related to FX trading, visit: Bank for International Settlements www.bis.org

  7. FX Risk Exposure • Greater exposure to a foreign currency combined with greater volatility of the foreign currency implies greater DEAR. • Dollar loss/gain in currency i = [Net exposure in foreign currency i measured in U.S. $] × Shock (Volatility) to the $/Foreign currency i exchange rate • Current issues related to falling value of the dollar against yen and euro

  8. FX Trading • FX markets turnover often greater than $1.8 trillion per day. • The market moves between Tokyo, NYC and London over the day allowing for what is essentially a 24-hour market. • Overnight exposure adds to the risk. • Implication: FIs need dependable measures of FX exposure.

  9. Trading Activities • Basically 4 trading activities: • Purchase and sale of currencies to complete international transactions. • Facilitating positions in foreign real and financial investments. • Accommodating hedging activities • Speculation. • Substantial risk arises via open positions

  10. Profitability of FX Trading • For large US banks, trading income is a major source of income. • Volatility of European currencies are declining (due to euro) • Volatility in Asian and emerging markets currencies higher but importance of these currencies remains relatively small • Risk arises from taking open positions in currencies

  11. Foreign Assets & Liabilities • Mismatches between foreign asset and liability portfolios • Ability to raise funds from internationally diverse sources presents opportunities as well as risks • Greater competition in well-developed (lower risk) markets

  12. Return and Risk of Foreign Investments • Returns are affected by: • Spread between costs and revenues • changes in FX rates • Changes in FX rates are not under the control of the FI • Not unlike exposure to interest rate risk

  13. Risk and Hedging • Hedge can be constructed on balance sheet or off balance sheet. • On - balance-sheet hedge will also require duration matching to control exposure to foreign interest rate risk. • Off-balance-sheet hedge using forwards, futures, or options.

  14. Interest Rate Parity Theorem • Equilibrium condition is that there should be no arbitrage opportunities available through lending and borrowing across currencies. This requires that 1+r(domestic) = (F/S)[1+r (foreign)] • Difference in interest rates will be offset by the expected change in exchange rates.

  15. Multicurrency Positions • Since the banks generally take positions in more than one currency simultaneously, their risk is partially reduced through diversification. • Overall, world bond markets are significantly, but not fully integrated which leaves open the opportunity to reduce exposure by diversifying.

  16. Diversification Effects (continued) • High correlations between the bond returns may be due to high correlation of real interest rates over time and/or inflation expectations. ri≈ rri + iei *Nominal return ≈ real return + E[inflation] *Note that this is only an approximation.

  17. Fisher Equation* The actual Fisher equation includes one additional term—cross product of inflation and real interest rate. ri = rri + iei + (rri × iei ) The last term will matter if inflation and/or real rate is large. Example: Consider hyperinflations in Brazil and other countries where the inflation rate may be in excess of 100% (or even >1000%).

  18. Pertinent Websites • For more information visit: Federal Reserve Bank www.federalreserve.gov Citigroup www.citigroup.com J.P. Morgan Chase www.jpmorganchase.com U.S. Treasury www.ustreas.gov

More Related