The currency exchange rates established for the currencies that the Bank trade with are the subject to change in accordance with the daily volatility in the international markets where such trade takes place.
Apart from the standard currency-based (exchange) services (FX), the Bank provides the corporate clients with a range of the modern services relating to financial market.
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The spot contract is a most frequent FX transaction form – amount in one currency is exchanged for the corresponding amount in another currency in accordance with the valid spot exchange market rate.
The contract is executed on the same day.
In order to carry out the spot transaction, in the request letter to the Bank the Client shall mention the amount and the currency pair- the currency that is offered for change ( currency to sell ) and the currency to which it will be exchanged ( currency to buy).
The risk that arises from the spot operations relates to the occurrence of the frequent and unexpected changes in the international market. Once the currency has been bought it is possible to have its price reduced in relation to another, a reference value currency, which consequently may result in the loss incurred by a participant in such spot operation.
FX forward contract is an agreement on purchase or sales of an amount of foreign currency at the point of time in future.
Forward contract shall be executed at the moment when a currency’s price in the international market reaches a level set at by the client.
FX forward contracts facilitate the investors to manage the currency risks (the exchange-rate risks) in the financial market by fixing the future currency exchange rate on a day when the currency transaction shall be carried out. Therefore, by using such contracts the investor is in position to:
Fix costs of products and services that have been bought at the foreign market
Protect profit margin on products and services that are sold to the foreign market.
Fix currency exchange rates in future
The forward currency exchange rates depend on the spot currency exchange rates and the ratio between the interest rates of two currencies, i.e. the difference between the revenues from the interest rate that may be earned in two countries during the same forward period.
FX forward operations are subject to the specific risks:
Credit risk (settlement risk) – same as with the most of financial instruments, the credit risks a risk that most frequently occurs. This risk is of one contracting parties failing to fulfill the contractually agreed obligation in the situation when the other contracting party shall conclude the contract with a third party (by which at the same time the said party is exposed to a market risk).
Currency market risk – the next important risk that arises from the FX forward is a possible unfavorable future ratio between of currency pair prices (exchange rates). By fixing the future exchange rate on the day when the currencies will be bough, the party gains an opportunity to profit due to a favorable change in the currency ratio. However, a contrary unfavorable change may bring the party to suffer the losses, so the economics effects of the transactions come down to the expectations associated with future trend.
Interest rate market risk – since the forward contract price is related to the expectations on the difference between the exchange rates applicable to the investments expressed in two different currencies, the interest rate changes may have effect on the price of the contract. If the party has concluded one forward contract, it does not lose a possibility to conclude another contract that will take into account a different ratio between the interest rates, and doing so it may have effect on mitigating the risk that arises from the interest rate volatility.
FX swap is a contract in which one party borrows one currency from, and simultaneously lends another to, the second party.
Such obligations are used as the collaterals for exposure to some currencies, while the future amounts for payment are fixed by the FX forwards. In that sense, FX swaps may be considered as riskless borrowings and money placements.
The contract virtually provides for using the funds expressed in one currency in order to meet the obligation defined in another currency, while the entire transaction does not bear the sensitivity to market currency risk.
In terms of the effects, FX swap is two contracts - spot and forward – packed in one contract.
FX swaps are mostly used by financial institutions for the purpose of the interest rate risk management.
The FX swaps are used by exporting and importing companies, as well as by the investors who want to be protected against the market risk.