Banks engage in currency trading, risk control, and operational risks on behalf of their customers and themselves, all of which expose them to exchange risks. There are four broad classes into which we might place these dangers:
Exchange Rate Risk
- In this context, we’re talking about the rise or fall in the value of one currency (the USD, for instance) relative to another (base currency like the INR). When a bank takes a long or short position in a currency, it exposes itself to the risk of loss if the underlying currency either decreases in value (in the case of a long position) or increases in value (in the case of a short position).
- Individual traders and investors who take on investment exposure may also be vulnerable to this danger.
- With the current conversion rate of 65 Indian rupees to one United States dollar, an Indian with a one million US dollar certificate of deposit in the United States would have around 6,50,00,000 Indian rupees in their CD. If the exchange rate suddenly drops to 50 INR: 1 USD, however, the Indian will only have 5,00,00,000 INR in the CD, although he will still have $1,000,000 in cash.
Credit Risk
- Investments are subject to credit risk or default risk if there is a chance that the borrower won’t be able to repay the loan. This may be due to the borrower’s shaky financial situation, and this sort of risk is always present. This danger might arise anytime between now and the contract’s expiration date.
- Avoiding financial losses is the goal of credit risk management, which entails keeping tabs on the adequacy of a bank’s capital and loan loss reserves. Limiting the number of transactions accepted from any one client depending on that customer’s creditworthiness and including cancellation provisions for when a counterparty’s rating drops may help mitigate credit risk.
- The Basel Committee suggests the following measures for risk management:
- Monitoring, assessing, and managing risks continuously.
- Efficient data processing systems
- Auditing and controlling processes
Liquidity Risk
- How many buyers and sellers there are in a market is what we call “liquidity.” Refinancing uncertainty is what we mean when we talk about liquidity risk.
- The danger of insufficient funds to cover current obligations to depositors and debtors is known as “liquidity risk.”
- If sold, illiquid assets will return less than their actual market value.
- A lack of willing purchasers makes a timely sale of an illiquid asset impossible.
Operational Risk
The bank’s operations are in danger due to operational risk.
The risk of loss results from a bank’s shortcomings or a failure in its control, operations, or processes.
Interest Rate Risk
- Interest rate risk refers to the potential loss in asset value (such as a bank’s) due to an unexpected shift in interest rates.
- This is a typical danger when purchasing a bond with a fixed interest rate. As interest rates rise, bond prices fall because the coupon rate is no longer competitive with market rates. With reduced demand in the market, the bond’s market price will stay the same, discouraging investors from making a purchase. The loss is only incurred once the bond is sold or matures.
- Long-term bonds have a greater interest rate risk since an unfavorable fluctuation might occur over an extended period.
- To reduce exposure to fluctuations in interest rates, investors might use hedging strategies or diversify their holdings among many kinds of securities. An interest rate swap is an option for investors seeking to hedge their portfolios.
Country Risk
The inability of a buyer’s nation to pay for imports is known as “country risk,” and it may affect any business transaction involving foreign investment or credit.
There is less chance of losing money if you invest in the nations listed in the table below.
Change in rank (from the previous year) Final Mark for Each Country (out of 100)
Top ten: 1 Singapore 88.6; 2 Norway 87.66; 3 Switzerland 87.64; 4 Denmark 85.67; 5 Sweden 85.59; 6 HTML-5 1 Luxembourg 83.85; 7 HTML-5 2 Netherlands 83.76; 8 HTML-5 3 Finland 83.1; 9 Canada 82.98; 10 HTML-5 3 Australia 82.18.
They were first published in January 2018 by Euromoney Country Risk.
The Golden Rules of Trading
Money management and psychology
- Financial planning is an essential aspect of risk assessment and mitigation.
- As important as knowing what drives the market and how to analyze it is, knowing how to manage risks and putting that knowledge into practice is even more crucial.
- If your forex broker gives you 1:50 leverage and you can make significant gains in the market with a small trading account, you probably need to start using sound money management. You could get fortunate for a day or two, but the absurd risk you’ve taken with such a large “transaction size” more than makes up for it. If you don’t implement risk management into your trading, you’re almost certain to suffer a catastrophic loss of capital if you keep going in this direction.
- Contrary to common assumption, traders often fail not because they need to gain knowledge of the current technical indication or comprehend fundamental factors but because they do not adhere to the most fundamental money management concepts. Money management is the most underrated and crucial aspect of trading in the financial markets.
- The term “money management” describes planning and executing one’s financial activities, such as budgeting, saving, investing, spending, and so on.
- Sound financial planning and a nutritional risk assessment will serve you well whether you’re trading stocks, commodities, or currencies.
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