As it was mentioned above trading on the Forex is
essentially risk-bearing. By the evaluation of the grade of a possible risk
accounted should be the following kinds of it: exchange rate risk, interest
rate risk, and credit risk, country risk. Exchange rate risk is the effect of
the continuous shift in the worldwide market supply and demand balance on an
outstanding foreign exchange position. For the period it is outstanding, the
position will be subject to all the price changes. The most popular measures to
cut losses short and ride profitable positions that losses should be kept
within manageable limits are the position limit and the loss limit. By the
position limitation a maximum amount of a certain currency a trader is allowed
to carry at any single time during the regular trading hours is to be
established.
The loss limit is a measure designed to avoid unsustainable
losses made by traders by means of stop-loss levels setting. Interest rate risk
refers to the profit and loss generated by fluctuations in the forward spreads,
along with forward amount mismatches and maturity gaps among transactions in
the foreign exchange book. This risk is pertinent to currency swaps; forward
outright, futures, and options (See below). To minimize interest rate risk, one
sets limits on the total size of mismatches. A common approach is to separate
the mismatches, based on their maturity dates, into up to six months and past
six months. All the transactions are entered in computerized systems in order
to calculate the positions for all the dates of the delivery, gains and losses.
Continuous analysis of the interest rate environment is necessary to forecast
any changes that may impact on the outstanding gaps.
Credit risk refers to the possibility that an outstanding
currency position may not be repaid as agreed, due to a voluntary or
involuntary action by a counter party. In these cases, trading occurs on
regulated exchanges, such as the clearinghouse of Chicago. The following forms
of credit risk are known:
Replacement risk occurs when counterparties of the failed
bank find their books are subjected to the danger not to get refunds from the
bank, where appropriate accounts became unbalanced.
Settlement risk occurs because of the time zones on
different continents. Consequently, currencies may be traded at the different
price at different times during the trading day. Australian and New Zealand
dollars are credited first, then Japanese yen, followed by the European
currencies and ending with the U.S. dollar. Therefore, payment may be made to a
party that will declare insolvency (or be declared insolvent) immediately
after, but prior to executing its own payments.
Therefore, in assessing the credit risk, end users must
consider not only the market value of their currency portfolios, but also the
potential exposure of these portfolios. The potential exposure may be
determined through probability analysis over the time to maturity of the
outstanding position. The computerized systems currently available are very
useful in implementing credit risk policies. Credit lines are easily monitored.
In addition, the matching systems introduced in foreign exchange since April
1993 are used by traders for credit policy implementation as well. Traders
input the total line of credit for a specific counterparty. During the trading
session, the line of credit is automatically adjusted. If the line is fully
used, the system will prevent the trader from further dealing with that counterparty.
After maturity, the credit line reverts to its original level.
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