Foreign Exchange Risk in Banks Overview and Analysis

Foreign win over stake in marges Overview and compendium target of the jump-The objective of this come across is to understand the various types of contrasted transfigure trys. And the capableness impact of the exotic switch all over risks on the institutions gnarly in overseas transfigure trading.Background-In this project, I have mensural the re vexe of risk involved in remote re-sentencing proceeding at United Bank of India. ruleology-The entropy employ in this project is obtained from helpary research. historic manner is utilize to calculate the quantify at take a chance (var). The pass judgment at venture is thus mensurable is used to find the existent amount at risk in harm of INR.Findings and Conclusion-By finding the aggregate risk, we get to manage the total amount that the organization undersurface lose in the beat come to the fore feasible scenario. It happens if the allocation of fund is non based upon the possible repute at risks . In carrying out this project, I have strand that the verify has allocated much funds for its forex operations than required.Recommendations-At present the bank is operational at the 99% trustingness take aim to calculate the mensu count at risk. As they are working at 99% office train, due(p) to this they take up to employ more large(p) for their forex operations. United Bank of India should see to it at 95% sureness aim. This allow for help them cut big mvirtuosoy funds employed for their forex operations.Introduction to Foreign transpositionThe creator of the human beings has non distributed resources pick outed by the civilised world evenly on our sa articulateite earth. What is uncommitted easily at iodin place is merely easy at other place. This has resulted in an environment of mutualness among the countries. The interdependency among countries has habituated rise to international trade. The growth of international trade of goods and function h as necessitated a mode of switch over.Let us evaluate a action involving cater of goods from India to United Kingdom. The prize of goods is bed to the Indian supplier in INR. indeed the Indian supplier forget footing the goods so that he canful make profit in INR. At the same succession the purchasing power available with the UK guest is in GBP ( smashing Britain Pound). thereof the customer volition want to know the price in GBP. Now, if buyer and vender root to settle the achievement in USD. Therefore to complete such(prenominal) transactions, the parties to the transaction lack to know the regard as of one gold in wrong of another. This mechanism of converting one property in terms of another is known as Foreign give-and-take.Foreign throw is delimitate in Foreign Exchange management Act 1999 as- on the whole deposits, opinions, balances tale collectable in either unusual currency and whatsoever drafts, travellers cheque, garner of credit and bil l of interchange expressed or drawn in Indian currency and payable in foreign currency. Any factor payable at the option of the drawee or holder thereof or any other party thereto, either in Indian currency or in foreign currency or partly in one and partly in the other.In short, Foreign Exchange is the method of novelty of one currency into another.As foreign currency is inured as a commodity, it is traded in a securities industry. Trade constitutes a undersized per centum of the Foreign Exchange Market. The cross border elbow grease of capital forms the major portion.Major participants of Foreign Exchange Market acknowledge technical banks, central banking institutions, investment banks, foreign supercede brokers and merchants. The commercial banks drop dead the vehicles for conversion, as nearly of the foreign commuting operation takes place by the account maintained with these banks.Objective of the ProjectA Project overcompensate on FOREIGN EXCHANGE risks in Ba nk.Foreign Exchange is a real large financial market. At propagation foreign substitute market becomes very volatile. This is responsible for the various risks in foreign central market. Everyone involved in the foreign deputise trading should we aware of foreign convince risk.To ascertain Foreign Exchange risk in Bank we need to execute the following tasks-Various types of foreign exchange serve available at Banks.The various types of foreign exchange risks.The various foreign currencies which has evidentiary demand.The possible Hedging st straygies that can be deployed to manage foreign exchange risks.Determination of revalue at essay (Var).Research Methodology entropy / breeding Collection.Study of selective information collected to calculate the value at risk (VAR).Calculation of mean yield.Calculation of beat excursion. entropy/Information CollectionData and information is collected from the various sources. These sources hold selective information from the Bank, magazines, journals, books and newspapers. The information thus collected is used to calculate the rank at fortune. prize at risk ( volt-ampere) take a chance is about betting odds of losing capital and VaR is based on that common sense fact. present risk is the odds of really big injury. Big loss is distinguishable for every investor depending on the investors appetite. But every investor whether big or broken does wants to know his/her losses in the worst trip. VAR answers the question, What is my worst- aspect scenario?To calculate VaR we need three components. These three components are a time menstruum, a trustfulness take and a loss amount or loss percentage. apply VaR investor give get to know things likeWhat is the most I can expect to lose with 95% pledge over a block of 10 eld?What is the maximum percentage I can expect to lose with 95% authorisation over a closure of 10 old age?We consider a relatively mellow level of corpo respect trust, mostly 95% or 99% agency level. snip period taken can be anything like a day, 10 day, a month or a year depending upon what investor is looking for.A one day VAR of $10mm employ a hazard of 5% nitty-gritty that there is a 5% chance that the portfolio could lose more than $10mm in the next trading day.There are three methods of figure VaR the historical method, the parametric method also known as variance-covariance method and the four-card monte Carlo dissimulation.The historical Method The historical method barely re-organizes actual historical softens, putting them in order from worst to best. It hence assumes that narration testament repeat itself, from a risk perspective. We therefore put these selective information in the histogram that compare the frequency of lead. Tiny bars in histogram do the less frequent daily pitch while the highest menses in histogram represents the most frequent daily chase away.Parametric MethodThis method assumes that the production line r eturns are normally distributed. In this method we estimate just now deuce factors an anticipate return and a metre deflexion. These two factors rent us to plot a normal distribution curve. three-card monte Carlo pretext The triad method involves developing a model for future air price returns and running multiple hypothetical trials through the model. A Monte Carlo simulation refers to any method that randomly gene casts trials, but by itself does not tell us anything about the underlying methodology. Every run of Monte Carlo pretension gives different result. But differences between these results are likely to be very narrow.Calculation of apprise at put on the line (VaR)To calculate the value at risk, at first we need to collect the historical information. historic selective information is the historical exchange set of a particular foreign currency once morest INR. The foreign currencies which we are considering here are United States dollar mark (USD), Great Britai n Pound (GBP), Euro and Japanese Yen (JPY). We are considering these currencies because they are the major currencies as exchange is easily available for these currencies. We will calculate the value at risk the investor faces in case he/she invests in any of these currencies. At first we will consider the case in which an investor is investing in United States Dollar. The investor will buy United States Dollar in exchange of INR.USD/INRThe historical exchange stray for USD/INR for a period of 22 eld starting from 15th April 2011 to 6th May 2011 is as followsFrom the ordinary exchange graze the day-after-day return is found by using the statute minded(p) below indwelling log (Present date exchange rate/ preceding date exchange rate)The Value at venture from the higher up information is reckon by using the given over linguistic rule in outdoPERCENTILE (array of the biannual return,5%)Here the array of the semestrial return is the everyday return of the period for which historical data is taken. The southward attributes i.e., 5% tells that 95 times out of 100 the loss will not exceed the deliberate VaR. Therefore we can say with 95% confidence that the loss will not exceed the Value at Risk (VaR) thus metrical.From the preceding(prenominal) data the Value at Risk (VaR) metrical at 95% confidence level is 0.35%From the higher up data the Value at Risk (VaR) mensural at 99% confidence level is 0.46%Euro/INRThe historical exchange rate for Euro/USD for a period of 22 days starting from 15th April 2011 to 6th May 2011 is as followsEuro/USD Euro/INRHistorical exchange rate for Euro/INR is stubborn from the historical exchange rate of Euro/USD and USD/INR.Exchange rate of Euro/INR = Exchange rate of Euro/USD * Exchange rate of USD/INRIn this case over again the biannual return is found by using the prescript given belowNatural Logarithm (Present date exchange rate/ forward date exchange rate)The Value at Risk from the higher up data i s calculated by using the given formula in stand outPERCENTILE (array of the periodic return, 5%)Here the array of the periodic return is the everyday return of the period for which historical data is taken. The min attributes i.e., 5% tells that 95 times out of 100 the loss will not exceed the calculated VaR. Therefore we can say with 95% confidence that the loss will not exceed the Value at Risk (VaR) thus calculated.From the above data the Value at Risk (VaR) calculated at 95% confidence level is 1.21%.From the above data the Value at Risk (VaR) calculated at 99% confidence level is 1.53%.GBP/INRThe historical exchange rate for GBP/USD for a period of 22 days starting from 15th April 2011 to 6th May 2011 is as followsGBP/USD GBP/INRHistorical exchange rate for GBP/INR is determined from the historical exchange rate of GBP/USD and USD/INR.Exchange rate of GBP/INR = Exchange rate of GBP/USD * Exchange rate of USD/INRIn this case again the periodic return is found by using the for mula given belowNatural Logarithm (Present date exchange rate/ previous date exchange rate)The Value at Risk from the above data is calculated by using the given formula in excelPERCENTILE (array of the periodic return, 5%)Here the array of the periodic return is the everyday return of the period for which historical data is taken. The second attributes i.e., 5% tells that 95 times out of 100 the loss will not exceed the calculated VaR. Therefore we can say with 95% confidence that the loss will not exceed the Value at Risk (VaR) thus calculated.From the above data the Value at Risk (VaR) calculated at 95% confidence level is 0.49%From the above data the Value at Risk (VaR) calculated at 99% confidence level is 1.03%JYP/INRThe historical exchange rate for USD/JYP for a period of 22 days starting from 15th April 2011 to 6th May 2011 is as followsUSD/JYP JPY/USDHistorical exchange rate for JPY/USD is determined from the historical exchange rate of USD/JPY.Exchange rate of JPY/USD = 1/ (Exchange rate of USD/JPY)JPY/INRHistorical exchange rate for JPY/INR is determined from the historical exchange rate of JPY/USD and USD/INR.Exchange rate of JPY/INR = Exchange rate of JPY/USD * Exchange rate of USD/INRIn this case again the periodic return is found by using the formula given belowNatural Logarithm (Present date exchange rate/ previous date exchange rate)The Value at Risk from the above data is calculated by using the given formula in excelPERCENTILE (array of the periodic return, 5%)Here the array of the periodic return is the everyday return of the period for which historical data is taken. The second attributes i.e., 5% tells that 95 times out of 100 the loss will not exceed the calculated VaR. Therefore we can say with 95% confidence that the loss will not exceed the Value at Risk (VaR) thus calculated.From the above data the Value at Risk (VaR) calculated at 95% confidence level is 0.60%From the above data the Value at Risk (VaR) calculated at 99% confidence l evel is 0.93%Calculation of banal DeviationStandard deviation is a gradation of how far away the data are from the ordinary of the data. If all the observations are close to their average then the standard deviation will be small.In finance, standard deviation is applied to the annual rate of return of an investment to measure the investments excitability. Standard deviation is also known as historical volatility and is used by investors as a gauge for the amount of expected volatility. cypher that an investor has INR 45,000 to invest and is considering buying the USD. Currently one USD is valued at INR 45. The investor assesses a 0.75 probability that the USD will appreciate against INR over a glide path period, so that one USD will be equivalent to INR 46 and a 0.25 probability that the USD will depreciate against INR to become impact to INR 44.INR 45,000 (at one USD equal to INR 45) = 45,000/45 = USD atomic number 19The payoffs from the proposed investment are as follows-I f the USD appreciates (One USD becomes equal to INR 46)USD 1000 *46 = INR 46,000If the USD depreciates (One USD becomes equal to INR 44)USD 1000*44 = INR 44,000PAYOFF(INR)RATE OF furnish fortuneEXPECTEDRATE OFRETURNVARIANCE(1)(2)(3)(4) = (2) x (3)(5)46,000(46 45)/45 = 0.0220.750.0165(0.022 0.011)2 x 0.75 = 0.Foreign Exchange Risk in Banks Overview and AnalysisForeign Exchange Risk in Banks Overview and AnalysisObjective of the Project-The objective of this project is to understand the various types of foreign exchange risks. And the potential impact of the foreign exchange risks on the institutions involved in foreign exchange trading.Background-In this project, I have calculated the value of risk involved in foreign exchange transactions at United Bank of India.Methodology-The data used in this project is obtained from secondary research. Historical method is used to calculate the Value at Risk (VaR). The Value at Risk is thus calculated is used to find the actual amount at ris k in terms of INR.Findings and Conclusion-By finding the total risk, we get to know the total amount that the organization can lose in the worst possible scenario. It happens if the allocation of fund is not based upon the possible value at risks. In carrying out this project, I have found that the bank has allocated more funds for its forex operations than required.Recommendations-At present the bank is operating at the 99% confidence level to calculate the value at risk. As they are working at 99% confidence level, due to this they need to employ more capital for their forex operations. United Bank of India should operate at 95% confidence level. This will help them cut down funds employed for their forex operations.Introduction to Foreign ExchangeThe creator of the universe has not distributed resources needed by the civilised world evenly on our planet earth. What is available easily at one place is hardly available at another place. This has resulted in an environment of interd ependency among the countries. The interdependency among countries has given rise to international trade. The growth of international trade of goods and services has necessitated a method of exchange.Let us evaluate a transaction involving supply of goods from India to United Kingdom. The value of goods is known to the Indian supplier in INR. Thus the Indian supplier will price the goods so that he can make profit in INR. At the same time the purchasing power available with the UK customer is in GBP (Great Britain Pound). Therefore the customer will want to know the price in GBP. Now, if buyer and seller decide to settle the transaction in USD. Therefore to complete such transactions, the parties to the transaction need to know the value of one currency in terms of another. This mechanism of converting one currency in terms of another is known as Foreign Exchange.Foreign Exchange is defined in Foreign Exchange management Act 1999 as- All deposits, credits, balances payable in any fo reign currency and any drafts, travellers cheque, letter of credit and bill of exchange expressed or drawn in Indian currency and payable in foreign currency. Any instrument payable at the option of the drawee or holder thereof or any other party thereto, either in Indian currency or in foreign currency or partly in one and partly in the other.In short, Foreign Exchange is the method of conversion of one currency into another.As foreign currency is treated as a commodity, it is traded in a market. Trade constitutes a small portion of the Foreign Exchange Market. The cross border movement of capital forms the major portion.Major participants of Foreign Exchange Market include commercial banks, central banking institutions, investment banks, foreign exchange brokers and merchants. The commercial banks become the vehicles for conversion, as most of the foreign exchange operation takes place through the account maintained with these banks.Objective of the ProjectA Project Report on FORE IGN EXCHANGE risks in Bank.Foreign Exchange is a very large financial market. At times foreign exchange market becomes very volatile. This is responsible for the various risks in foreign exchange market. Everyone involved in the foreign exchange trading should we aware of foreign exchange risk.To ascertain Foreign Exchange risk in Bank we need to execute the following tasks-Various types of foreign exchange services available at Banks.The various types of foreign exchange risks.The various foreign currencies which has significant demand.The possible Hedging strategies that can be deployed to manage foreign exchange risks.Determination of Value at Risk (Var).Research MethodologyData / Information Collection.Study of data collected to calculate the value at risk (VAR).Calculation of mean return.Calculation of Standard Deviation.Data/Information CollectionData and information is collected from the various sources. These sources include data from the Bank, magazines, journals, books and newspapers. The information thus collected is used to calculate the Value at Risk.Value at risk (VaR)Risk is about odds of losing money and VaR is based on that common sense fact. Here risk is the odds of really big loss. Big loss is different for every investor depending on the investors appetite. But every investor whether big or small does wants to know his/her losses in the worst case. VAR answers the question, What is my worst-case scenario?To calculate VaR we need three components. These three components are a time period, a confidence level and a loss amount or loss percentage. Using VaR investor will get to know things likeWhat is the most I can expect to lose with 95% confidence over a period of 10 days?What is the maximum percentage I can expect to lose with 95% confidence over a period of 10 days?We consider a relatively high level of confidence, mostly 95% or 99% confidence level.Time period taken can be anything like a day, 10 day, a month or a year depending upon what investor is looking for.A one day VAR of $10mm using a probability of 5% means that there is a 5% chance that the portfolio could lose more than $10mm in the next trading day.There are three methods of calculating VaR the Historical method, the parametric method also known as variance-covariance method and the Monte Carlo simulation.The Historical Method The historical method simply re-organizes actual historical returns, putting them in order from worst to best. It then assumes that history will repeat itself, from a risk perspective. We then put these data in the histogram that compare the frequency of return. Tiny bars in histogram represent the less frequent daily return while the highest point in histogram represents the most frequent daily return.Parametric MethodThis method assumes that the stock returns are normally distributed. In this method we estimate only two factors an expected return and a standard deviation. These two factors allow us to plot a normal distribution curve.Monte Carlo Simulation The third method involves developing a model for future stock price returns and running multiple hypothetical trials through the model. A Monte Carlo simulation refers to any method that randomly generates trials, but by itself does not tell us anything about the underlying methodology. Every run of Monte Carlo Simulation gives different result. But differences between these results are likely to be very narrow.Calculation of Value at Risk (VaR)To calculate the value at risk, at first we need to collect the historical data. Historical data is the historical exchange rate of a particular foreign currency against INR. The foreign currencies which we are considering here are United States Dollar (USD), Great Britain Pound (GBP), Euro and Japanese Yen (JPY). We are considering these currencies because they are the major currencies as exchange is easily available for these currencies. We will calculate the value at risk the investor faces in case he/she inves ts in any of these currencies. At first we will consider the case in which an investor is investing in United States Dollar. The investor will buy United States Dollar in exchange of INR.USD/INRThe historical exchange rate for USD/INR for a period of 22 days starting from 15th April 2011 to 6th May 2011 is as followsFrom the everyday exchange rate the periodic return is found by using the formula given belowNatural Logarithm (Present date exchange rate/ previous date exchange rate)The Value at Risk from the above data is calculated by using the given formula in excelPERCENTILE (array of the periodic return,5%)Here the array of the periodic return is the everyday return of the period for which historical data is taken. The second attributes i.e., 5% tells that 95 times out of 100 the loss will not exceed the calculated VaR. Therefore we can say with 95% confidence that the loss will not exceed the Value at Risk (VaR) thus calculated.From the above data the Value at Risk (VaR) calcula ted at 95% confidence level is 0.35%From the above data the Value at Risk (VaR) calculated at 99% confidence level is 0.46%Euro/INRThe historical exchange rate for Euro/USD for a period of 22 days starting from 15th April 2011 to 6th May 2011 is as followsEuro/USD Euro/INRHistorical exchange rate for Euro/INR is determined from the historical exchange rate of Euro/USD and USD/INR.Exchange rate of Euro/INR = Exchange rate of Euro/USD * Exchange rate of USD/INRIn this case again the periodic return is found by using the formula given belowNatural Logarithm (Present date exchange rate/ previous date exchange rate)The Value at Risk from the above data is calculated by using the given formula in excelPERCENTILE (array of the periodic return, 5%)Here the array of the periodic return is the everyday return of the period for which historical data is taken. The second attributes i.e., 5% tells that 95 times out of 100 the loss will not exceed the calculated VaR. Therefore we can say with 95% confidence that the loss will not exceed the Value at Risk (VaR) thus calculated.From the above data the Value at Risk (VaR) calculated at 95% confidence level is 1.21%.From the above data the Value at Risk (VaR) calculated at 99% confidence level is 1.53%.GBP/INRThe historical exchange rate for GBP/USD for a period of 22 days starting from 15th April 2011 to 6th May 2011 is as followsGBP/USD GBP/INRHistorical exchange rate for GBP/INR is determined from the historical exchange rate of GBP/USD and USD/INR.Exchange rate of GBP/INR = Exchange rate of GBP/USD * Exchange rate of USD/INRIn this case again the periodic return is found by using the formula given belowNatural Logarithm (Present date exchange rate/ previous date exchange rate)The Value at Risk from the above data is calculated by using the given formula in excelPERCENTILE (array of the periodic return, 5%)Here the array of the periodic return is the everyday return of the period for which historical data is taken. The secon d attributes i.e., 5% tells that 95 times out of 100 the loss will not exceed the calculated VaR. Therefore we can say with 95% confidence that the loss will not exceed the Value at Risk (VaR) thus calculated.From the above data the Value at Risk (VaR) calculated at 95% confidence level is 0.49%From the above data the Value at Risk (VaR) calculated at 99% confidence level is 1.03%JYP/INRThe historical exchange rate for USD/JYP for a period of 22 days starting from 15th April 2011 to 6th May 2011 is as followsUSD/JYP JPY/USDHistorical exchange rate for JPY/USD is determined from the historical exchange rate of USD/JPY.Exchange rate of JPY/USD = 1/ (Exchange rate of USD/JPY)JPY/INRHistorical exchange rate for JPY/INR is determined from the historical exchange rate of JPY/USD and USD/INR.Exchange rate of JPY/INR = Exchange rate of JPY/USD * Exchange rate of USD/INRIn this case again the periodic return is found by using the formula given belowNatural Logarithm (Present date exchange ra te/ previous date exchange rate)The Value at Risk from the above data is calculated by using the given formula in excelPERCENTILE (array of the periodic return, 5%)Here the array of the periodic return is the everyday return of the period for which historical data is taken. The second attributes i.e., 5% tells that 95 times out of 100 the loss will not exceed the calculated VaR. Therefore we can say with 95% confidence that the loss will not exceed the Value at Risk (VaR) thus calculated.From the above data the Value at Risk (VaR) calculated at 95% confidence level is 0.60%From the above data the Value at Risk (VaR) calculated at 99% confidence level is 0.93%Calculation of Standard DeviationStandard deviation is a measure of how far apart the data are from the average of the data. If all the observations are close to their average then the standard deviation will be small.In finance, standard deviation is applied to the annual rate of return of an investment to measure the investmen ts volatility. Standard deviation is also known as historical volatility and is used by investors as a gauge for the amount of expected volatility.Suppose that an investor has INR 45,000 to invest and is considering buying the USD. Currently one USD is valued at INR 45. The investor assesses a 0.75 probability that the USD will appreciate against INR over a coming period, so that one USD will be equivalent to INR 46 and a 0.25 probability that the USD will depreciate against INR to become equal to INR 44.INR 45,000 (at one USD equal to INR 45) = 45,000/45 = USD 1000The payoffs from the proposed investment are as follows-If the USD appreciates (One USD becomes equal to INR 46)USD 1000 *46 = INR 46,000If the USD depreciates (One USD becomes equal to INR 44)USD 1000*44 = INR 44,000PAYOFF(INR)RATE OFRETURNPROBABILITYEXPECTEDRATE OFRETURNVARIANCE(1)(2)(3)(4) = (2) x (3)(5)46,000(46 45)/45 = 0.0220.750.0165(0.022 0.011)2 x 0.75 = 0.