What are the major risk in foreign exchange dealings?


Ans: Cash balance risk: Cash balances refers to the actual balances maintained in the “Nostro Account” at the end of each day. Balances in “Nostro Account” do not earn any interest on the other hand any overdraft involves payment of interest.  


Reason of the risk:   



Maturity mismatches risk: This risk arises on account of maturity period of purchase & sale contract of foreign currency not coinciding or matching.  The cash flow mismatches between purchases & sales thereby leaves a gap at the end of each period. Therefore the risk also known as ‘liquidity risk’ or ‘gap risk’.   Reason of the risk

  • Under forward contracts, the customers may exercise their option on any day during the month which may not match with the option under the cover contract. With the market with maturity towards the month end.
  • Non availability of matching forward cover in the market for the volume and maturity desired.
  • Small value of merchant contracts may not aggregate to the round sums for which cover contracts are available.
  • In the inter bank contracts, the buyer bank may pick up the contract on any day during the option period.



“Maturity limit”: When bank fix the maximum period up ot which forward cover can be offered to the customer is called maturity limit. This depends upon the maximum maturity for which cover will be available in the market.



Credit risk: Credit risk is the risk of failure of counterparty to the contract. Credit risk may be classified into two categories.

These are:   Contract risk: It arises when failure of the counterparty is known to the bank before it executes its part of the contract.  

Clean risk:  It arises when the bank has executed the contract, but the counterparty has not done its part.



Country Risk: Also known as ‘sovereign risk” or ‘Transfer risk’. Country risk refers to the ability & willingness of a country to service its external liabilities. It refers to the possibility that the Government as well as borrowers of a particular country may be unable to fulfill their obligations under foreign exchange transactions due to reasons which are beyond the usual credit risks.


Overtrading risks: A bank runs the risk of overtrading if the volume of transactions indulged by it is beyond its Administrative & Financial capacity.  


Fraud Risk: Fraud risk may be indulged in by the dealers or by other operational staff for personal gain or to conceal a genuine mistake committed earlier. Frauds may take the form of dealing for one’s own benefit without putting them through the bank accounts.  



Operational risk: This risk includes inadvertent mistakes in the rates, amounts and counterparties of deals, misdirection of funds etc. The reason may be human errors or administrative inadequacies.


Interest rate risk: It arises from movements in interest rates in the market. The interest rate exposure is created from the mismatches in the interest re pricing tenors of assets & liabilities of an organization.


What do you mean by Value at Risk (VAR)?

Ans. Value at Risk is a statistical measure of the worst probable loss on a position or portfolio of positions that can be expected over a specified period of time to a given level of confidence.

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