1 / 10

Foreign Exposure Risk

Foreign Exposure Risk. By Pete Schonebaum March 4, 2008. Risks for firms Book examples Issues concerning forex risk 1 Exchange risk for a firm-how to measure Hedging strategy Tools to apply 1 Giddy,Ian. Management of Foreign Exchange Risk. Intro to Concept. Risk Measurement.

taima
Download Presentation

Foreign Exposure Risk

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. Foreign Exposure Risk By Pete Schonebaum March 4, 2008

  2. Risks for firms Book examples Issues concerning forex risk1 Exchange risk for a firm-how to measure Hedging strategy Tools to apply 1 Giddy,Ian. Management of Foreign Exchange Risk Intro to Concept

  3. Risk Measurement • Two underlying variables • Volatility of exchange rate • Level of exposure • General scenarios • Fixed exchange rate: low risk • Exposed and low variance of exchange rate: moderate risk • Exposed and high variance of exchange rate: high risk

  4. Exchange Rate Risk • Real or nominal? • Typically measured using nominal • When to use real? • When inflation differentials affect nominal • Example: Mexican Peso nominal variance =2392 real variance=1561

  5. Calculating Exchange Rate Risk • Determine exchange rates over period • Calculate percentage change • Determine standard deviation of percentage changes • Assuming normal distribution • Example

  6. Exchange Risk: One Currency • Example: • Receivable of 2 million bugaboos in 1 month • Standard deviation of % change (1 mnth): 4.5% • 30 day forward rate: 1.5$/bugaboo • Expected exposure? • Foreign exchange risk?

  7. Exchange Risk: Multiple Currencies • Currency diversification • Firms face less risk • Risk and exposure cannot be added with multiple currencies • Correlation effects • Positive correlation: total exposure=approximate sum of two exposures • Negative correlation: risk and exposure cannot be added

  8. Exchange Risk: Multiple Currencies • Example: • $100 worth of IL, $100 worth of JPY • Variance IL/$: 520, Variance JPY/$: 600 • Covar of IL & JPY: 275 • What is the exchange risk of this portfolio?

  9. Exchange Risk and Firm Cash Flows • What: Relate currency portfolio risk with volatility of firm cash flows • How: • Devise ratio of portfolio st.deviation with that of firm cash flows • Run regression-cash flows as dependent, exchange rate as independent • Low R2 indicates low exchange risk

  10. Value at Risk • Definition: greatest possible loss over specified horizon, given confidence interval1 • Example: • Portfolio value: $10 million • Standard deviation of currency portfolio: 15% over 1 year • 99% confidence= 2.57 standard deviations • VAR=0.15 X 2.57 X $10 million =$3.85 million • Common terms: “Most we can lose, under normal market conditions, is $3.85 million.” 1: Click, Reid. International Financial Management

More Related