exchange rate risk kind of foreign exchange market

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Don't forget to check out  Credit Risk and Interest Rate Risk  its related to this article from here

On the foreign exchange market one discerns the following kinds of the
risks:

 • exchange rate risk;
• interest rate risk;
• credit risk;
• country risk.

Exchange Rate Risk :-

Exchange rate risk is a consequence of the continuous shift in the worldwide market supply and demand balance on an outstanding foreign exchange position. A position will be a subject to all the price changes as long as it is outstanding. In order to cut losses short and ride profitable positions that losses should be kept within manageable limits. The most popular steps are the position limit and the loss limit. The limits are a function of the policy of the banks along with the skills of the traders and their specific areas of expertise. There are two types of position limits: daylight and overnight.

1. The daylight position limit establishes the maximum amount of a certain currency which a trader is allowed to carry at any single time during. The limit should reflect both the trader's level of trading skills and the amount at which a trader peaks.

2. The overnight position limit which should be smaller than daylight limits refers to any outstanding position kept overnight by traders. Really, the majority of foreign exchange traders do not hold overnight positions.

The loss limit is a measure to avoid unsustainable losses made by traders; which is enforced by the senior officers in the dealing center.

The position and loss limits can now be implemented more conveniently with the help of computerized systems which enable the treasurer and the chief trader to have continuous, instantaneous, and comprehensive access to accurate figures for all the positions and the profit and loss. This information may also be delivered from all the branches abroad into the headquarters terminals.

Country Risk

The failure to receive an expected payment due to government interference amounts to the insolvency of an individual bank or institution, a situation described under credit risk. Country risk refers to the government's interference in the foreign exchange markets and falls under the joint responsibility of the treasurer and the credit department. Outside the major economies, controls on foreign exchange activities are still present and actively implemented.

For the traders it is important to know or be able to anticipate any restrictive changes concerning the free flow of currencies. If this is possible, though trading in the affected currency will dry up considerably, it is still a manageable situation.

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Posted in: CHAPTER 7 Foreign Exchange Risks