Foreign Exchange Risk Appraisal
Is aimed at determining where the company’s exposure stands vis-à-vis market forecasts.
The following risks will be considered:
1. Value at Risk (VAR) or Risk to the Exposure
Is when you give a particular view or forecast and where value at risk (VAR) tries to determine by how much the company’s underlying cash flows will be affected. The Value at risk, “If the Rate actually moves to position X, how much Profit or Loss does the company stand to make?”
2) Forecast Risk
Before deciding on a Benchmark and devising a hedging strategy it is imperative to work out what is the possibility of the rate actually moving to position X and what is the possibility of a forecast going wrong.
3) Market and Transaction Risk
Is when you take into consideration any risks attached with each particular market and the risk of a transaction not going through as suspected. For instance,
- The AUD is given to sudden swings in sentiment, whereas the USD is generally more predictable. - The monetary and time costs of hedging with a nationalised bank are generally higher than with a private/foreign bank.
4) Systems Risk
This can relate to any risks that arise through weaknesses or gaps in the Exposure Management system. For example
**- Reporting Gap** – Delays/ errors in reporting, unnecessary exposure. **- Implementation Gap** – Can be if there is a gap or timescale between the decision to hedge and the implementation of that hedge decision.
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