Question

Banks find the necessary to accommodate their clients’ needs to buy or sell fx forward, in many instances for hedging purposes. discuss ways the bank eliminates the currency exposure it has created for itself by accommodating a client’s forward transaction.

Answer 1

Banks eliminate their currency exposure from client's forward FX transactions by engaging in offsetting trades in the interbank market, or by using currency derivatives like swaps and options to hedge their risk.

Step-by-step explanation:

Banks that accommodate client’s forward foreign exchange transactions often have to manage the resulting currency exposure. To eliminate this exposure, banks can undertake a variety of hedging strategies in the interbank market, where they trade currencies amongst themselves and with other financial institutions.One common method is to engage in offsetting transactions that mirror the client's trade. For instance, if a bank has sold euros forward to a client, it can buy the same amount of euros forward in the interbank market. By doing so, the bank ensures that any gains or losses on the client's position are offset by corresponding losses or gains on its own position.

Banks can also use currency swaps, options, or futures contracts to hedge their exposure. These financial instruments allow banks to lock in prices or rates, thereby minimizing the risk that comes from fluctuations in currency values. Further risk management strategies may include matching the maturities of their hedges with the timeline of client contracts and diversifying currency exposures across multiple currencies and financial instruments.