Managing Currency Risk: Using Financial Derivatives by John J. Stephens

By John J. Stephens

Keep watch over the #1 reason for monetary loss foreign money fluctuationWith cross-border trade now the worldwide norm, businesses needs to now face the best risk to their monetary balance: monetary losses as a result of foreign money fluctuations. Written by way of a global enterprise and banking professional, dealing with forex threat is an authoritative, available examine the diversity of tools used to lessen foreign money possibility. Written for the monetary marketplace amateur, the ebook explains the character and makes use of of various monetary tools with no complex mathematical equations. mentioned intimately are all varieties of forex derivatives, comparable to ahead foreign currency, OTC forex concepts, forex swaps, foreign money futures, and strategies that are illustrated with overseas examples and case experiences. a pragmatic consultant on each element of forex probability, coping with forex possibility additionally serves as a consultant to navigating your company via turbulent financial instances.

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The proposition can be illustrated by considering a company that expects a profit of £20 million or a £10 million loss with equal probability. The expected cash flow of the company is therefore £5 million [(£20 million × 50%) + ( _ £10 million × 50%) = £5 million]. Assume that the company manages to hedge its risk in such a way that it has a guaranteed profit of £5 million after the hedge. All that has happened is that the risk has been reduced, since the expected cash flow remains the same as before.

Although it might be a very effective strategy in a particular transaction, it may be an unwise strategy as a general rule. If the firm’s suppliers and clients are always obliged to accept the currency risk when trading with that firm, a few losses may quickly turn them away as clients or suppliers. They may well start looking for trading partners that are more accommodating than a firm with an inflexible policy of currency risk avoidance. It follows that active currency risk management strategies could even provide a competitive edge for a company where its competitors are so totally risk-averse as to avoid currency risk altogether.

There must obviously be a limit to the liability of the option seller. The option therefore has a size. In an OTC option the size of the option will be determined by agreement between the parties at the outset. Since the option buyer in the case of the above example, wishes to obtain yen, the size of the option will be agreed in terms of a quantity of yen, being the amount of yen that the option buyer wishes to acquire. There are a number of other qualities of options that are fully discussed later in the 24 CURRENCY RISK, CURRENCY DERIVATIVES AND THE MANAGEMENT FUNCTION book.

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