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Fx Risk Exposures

In: Business and Management

Submitted By blaine
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FX risk exposures
FX risk is the possibility of loss due to an unexpected movement in an exchange rate. It is faced when a party decides to exchange currencies and exists for the period between this decision and when the trade is made in the FX market.

Foreign currency assets, for example an investment in US stocks by AMP, are exposed to the risk of an appreciation of the AUD whereas holders of foreign currency liabilities (such as an Australian bank that has issued securities in a foreign currency) face the risk of a depreciation of the domestic currency since such a movement would increase the domestic currency’s value of the liabilities.

Importers have to pay in the foreign currency and so face the risk of a depreciation in the AUD, since this increases the AUD cost of the foreign currency in which the imported items are sold. Whereas exporters face the risk an appreciation in the AUD since this would reduce the AUD value of the foreign currency earnings.
Hedging with forward contracts
A forward FX contract is an agreement to exchange currencies at a future settlement. The amounts to be exchanged are set by the forward exchange rate. This rate provides the hedge because it removes the risk of an adverse movement in the exchange rate prior to settlement. It also removes the benefit of a favourable exchange rate movement. To illustrate, suppose AMP decided to return next month USD20m to its Australian clients being the proceeds from maturing bonds. AMP can ensure that the funds will be returned at the current spot rate (let’s say it is USD/AUD1.3420), adjusted for the difference between the two interest rates, by selling the USD in a one-month forward contract. Hence the AUD proceeds of its clients are not exposed to the risk of a possible appreciation in the AUD over the next month. But the investor clients will not benefit should the AUD depreciate over…...

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