FX risk

Question 1

why does FX risk occur? (4)

Answer 1

• trading in foreign currencies
• make FX loans
• buy FX issued securities
• issuing FX denominated bonds

Question 2

what is direct quotation?

Answer 2

FX in terms of domestic currency, ie $2.50 per £1

Question 3

indirect quotation is when?

Answer 3

the foreign currency in terms of domestic currency, ie £0.40 per $1

Question 4

what does the spot FX rate refer to?

Answer 4

current FX rate, ie immediate exchange.

Question 5

what does the forward FX refer to?

Answer 5

the prespecified FX rate at some future date

Question 6

when does substantial risk arise in FX trading?

Answer 6

when traders assume an open position, ie speculation

Question 7

Net exposure , of an FI:= (FX assetsi–FX liabilitiesi) + (FX boughti–FX soldi). (in a particular currency) what does NET long and NET short mean?

Answer 7

• NET long: assets>liabilities

- NET short: liabilities>assets

Question 8

what risk does a firm face when it have a NET long position in a particular FX?

Answer 8

The risk that the FX currency will depreciate and,

the risk that the domestic currency will appreciate

Question 9

what risk does a firm face when it have a NET short position in a particular FX?

Answer 9

The risk that the FX currency will appreciate and,

the risk that the domestic currency will depreciate

Question 10

When does the daily earnings at risk (DEAR) value increase?

Answer 10

when there is greater exposure to an FX and the FX has greater volatility.

Question 11

how to measure an FI’s FX exposure:

Dollar loss/gain in currency i=

Answer 11

Net exposure in foreign currency i measured in local currency×shock (volatility) to the $/foreign currency i exchange rate

Question 12

if interest rates were higher in AUS compared to the US, how would this be reflected in the FX?

Answer 12

you would expect the AUD to be stronger against the USD