A good foreign
exchange policy is critical to the sound risk management of any corporate
treasury. Without a policy decision are made as-hoc and generally without any
consistency and accountability. It is important for treasury personnel to know
what benchmarks they are aiming for and it’s important for senior management or
the board to be confident that the risk of the business are being managed
consistently and in accordance with overall corporate strategy.
Scenario
Planning – Making Rational Decisions
The recognition
of the financial risks associated with foreign exchange mean some decision
needs to be made. The key to any good management is a rational approach to
decision making. The most desirable method of management is the pre-planning of
responses to movements in what are generally volatile markets so that emotions
are dispensed with and previous careful planning is relied upon. This approach
helps eliminate the panic factor as all outcomes have been considered including
‘worst case scenarios’, which could result from either action or inaction.
However even though the worst case scenarios are considered and plans ensure
that even the ‘worst case scenarios’ are acceptable (although not desirable),
the pre-planning focuses on achieving the best result.
VAR (Value at Risk)
Banks trading in securities, foreign
exchange, and derivatives but with the increased volatility in exchange rates
and interest rates, managements have become more conscious about the risks
associated with this kind of activity As a matter of fact more and more banks
hake started looking at trading operations as lucrative profit making activity
and their treasuries at times trade aggressively. This has forced the
regulator’ authorities to address the issue of market risk apart from credit
risk, these market players have to take an account of on-balance sheet and
off-balance sheet positions. Market risk arises on account of changes in the
price volatility of traded items, market sentiments and so on.
Globally
the regulators have prescribed capital adequacy norms under which, the risk
weighted value for each group of assets owned by the bank is calculated
separately, and then added up The banks have to provide capital, at the
prescribed rate, for total assets so arrived at.
However this does not
take care of market risks adequately. Hence an alternative approach to manage
risk was developed for measuring risk on securities and derivatives trading
books. Under this new-approach the banks can use an in-house computer model for
valuing the risk in trading books known as ‘VALUE AT RISK MODEL (VaR MODEL).
Under
VaR model risk management is done on the basis of holistic approach unlike the
approach under which the risk weighted value for each group of assets owned by
a bank is calculated separately.
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