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FRM - Schweser - Topic 33
Foreign Exchange Risk
10
Finance
Professional
03/22/2010

Additional Finance Flashcards

 


 

Cards

Term
How can a bank's actual exposure to any given currency be measured?
Definition

by the net position exposure

This is the extent which which a bank is net long (positive) or net short (negative) in a given currency.

 

 

Term
Formula for working out a bank's net euro exposure?
Definition

net EUR exposure = (EUR assets - EUR liabilities) + (EUR bought) - (EUR sold)

 

 

can be expressed as:

 

net EUR exposure = net EUR assets + net EUR bought

Term

What does a positive net exposure position mean?

 

If we have a positive net exposure position, what foreign exchange risk are we concerned about?

Definition

positive net exposure position means we are net long in a currency.

 

hold more assets than liabilities in a given currency.

 

If positive net exposure, the institution faces the risk that the foreign currency will fall in value against the domestic currency (assets will then be worth less in the domestic currency)

Term

What's another name for net short in a currency?

 

If this is the case, what is the risk?

Definition

net short in a currency = negative net exposure position in a currency

 

risk is that the the foreign currency will rise in value against the domestic currency (liabilities will then be worth more in the domestic currency)

Term
List and describe the different types of foreign exchange trading activities financial institutions take part in:
Definition
  1. Enabling customers to participate in international commercial business transactions
  2. Enabling customers to take positions in real or financial foreign investments
  3. Offsetting exposure in a given currency for hedging purposes
  4. Speculating on foreign currencies in search of profit by forecasting and/or anticipating futures FX rate movements
Term
What are the two principal methods available to control the scale of FX exposure?
Definition

 - on balance sheet hedging: achieved when a financial institution has a matched maturity and currency foreign asset-liability book

 

 

- off balance sheet hedging: remain unhedged in the balance sheet but hedge off-balance by taking a position in the forward market.

Term
When is on-balance sheet hedging achieved?
Definition
- when a financial institution has a matched maturity and currency foreign asset-liability book
Term
Describe Interest Rate Parity:
Definition

IRP states that a firm should not be able to make excess profits from foreign investments (i.e. a higher domestic currency return from lending in a foreign corrency and locking in the forward rate of return

 

(from wiki) the spot price and the forward or futures price of a currency incorporate any interest rate differentials between the two currencies.

 

The equation:

forward = spot * [(1 + domestic currency rate) / (1 + foreign currency rate)]T

 

with continuous compounding:

 

forward = spot * e(rdc-rfc)T

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