Foreign Exchange Dealing, Derivatives, and Risk Management
Dealing and derivatives items test pricing, hedging, position management, and the risk taxonomy for a foreign exchange bank. Expect both conceptual questions and simple payoff or hedge calculations.
Instruments
Spot settles T+2. An FX forward fixes a rate for a future date. An FX swap is a spot purchase and forward sale (or the reverse) in one transaction, used for funding and liquidity rather than to take a directional view. FX options give the buyer a right, with premium and delta exposure. KRW NDFs are cash-settled in USD and are traded mainly offshore; they are not deliverable won contracts.
Risk management
Banks manage market risk (rate and volatility), credit risk (counterparty default), liquidity risk (funding mismatches), settlement risk (the Herstatt risk of paying before receiving), and operational risk. Position limits and VaR are standard controls; stress testing addresses tail scenarios that VaR misses.
Worked example
An importer must pay USD 1,000,000 in 90 days. The 90-day forward is 1,295.19; the importer buys USD forward and locks KRW 1,295,190,000. If spot at maturity is 1,340.00, the forward saves 44,810,000 KRW versus buying at spot. If spot is 1,250.00, the forward costs 45,190,000 KRW more, which is the price of certainty, not a mistake.
Traps
- Describing an FX swap as two unrelated trades or as an option.
- Forgetting that a forward hedge fixes the rate but not the underlying commercial outcome.
- Ignoring settlement risk because the counterparty is highly rated.
- Confusing NDF cash settlement with physical delivery of won.