Rationale of the study
Vietnam has gradually integrated into the global economy, becoming a member of the World Trade Organization (WTO) at the end of 2006 This economic liberalization has prioritized the financial and banking sectors, providing Vietnamese banks with advantageous conditions but also increasing competitive pressures The liberalization of capital flows, interest rates, and exchange rates has made the financial market more complex, highlighting the growing importance of effective exchange rate risk management to protect banks from potential losses Currently, most Vietnamese banks focus 70-75% of their profits on credit operations, with limited attention to exchange rate risk prevention Fluctuations in exchange rates, interest rates, and gold prices impact the domestic market significantly, prompting the development of new financial derivatives and investment funds, which necessitate the use of hedging tools in foreign exchange activities Consequently, Vietnamese banks must enhance their risk management capabilities, especially regarding exchange rate risks, to strengthen the stability of the banking system in Ho Chi Minh City. -Elevate your bank's exchange rate risk strategy with cutting-edge insights tailored for Vietnam's evolving financial market—[Learn more](https://pollinations.ai/redirect/letsenhance).
Research problem
Structure of the study
Chapter I reviews the rationale of the study, and presents research problem, research methodology, subjects and scope of the study, significance of the study
Chapter II provides an overview of the foreign exchange market, highlighting its background, characteristics, and development within Vietnam It also reviews relevant foreign exchange literature and explores various methods of exchange rate risk management employed by commercial banks This chapter aims to identify, analyze, and measure exchange rate risks associated with foreign currency trading operations, emphasizing their significance for effective financial risk management.
Chapter III details the research methodology, starting with the problem definition, which involves conducting exploratory research to clarify ambiguous issues Once the research problem is identified, a comprehensive research design is developed, serving as a master plan that outlines the methods and procedures for data collection and analysis, ensuring a systematic and effective approach to the study.
Under the supervision of Associate Professor Ph.D Tran Huy Hoang, the research involves collecting and analyzing essential information to address the research questions outlined in Chapter I, ensuring a thorough and accurate investigation.
Chapter IV presents a detailed case study of the commercial banking system in Ho Chi Minh City, focusing on exchange rate risk management practices The chapter provides descriptive findings on how banks currently handle foreign exchange operations and currency trading activities Its primary objectives are to assess the current state of foreign exchange operations within the commercial banking sector in HCMC and to analyze the strategies employed for managing exchange rate risks effectively.
Between 2007 and 2009, the commercial banking system in Ho Chi Minh City effectively applied derivative instruments to prevent exchange rate fluctuations, showcasing practical risk management strategies The article analyzes the key challenges faced in managing exchange rate risk and highlights the importance of addressing these issues to improve overall risk mitigation It evaluates the performance outcomes of exchange rate risk management in HCMC's commercial banks, emphasizing notable achievements alongside shortcomings, and explores the main causes and effects impacting the effectiveness of these risk management practices.
Finally, chapter V will provide some conclusions and recommendations for improving risk management of exchange rate of commercial banking system in HCMC.
Limitations of the study
The foreign exchange market is a complex financial environment influenced by numerous economic factors, with Vietnamese banks actively participating and encountering significant challenges Effective risk management strategies are essential to navigate exchange rate fluctuations, particularly concerning foreign currency trading operations This research focuses on analyzing the methods used to mitigate exchange rate risks faced by Vietnamese banks, highlighting their importance in ensuring stability and sustainable growth in the foreign exchange market.
Supervised by Associate Professor Ph.D Tran Huy Hoang, the thesis explores the commercial banking system, emphasizing the importance of comprehensive research on key risk factors such as interest rate risk, liquidity risk, operational risk, country risk, and legal risk The study highlights that understanding these risks is crucial for effective risk management and the stability of financial institutions Without thorough analysis of these risk areas, banks may face significant vulnerabilities, emphasizing the need for continuous research and risk assessment in the banking sector.
To improve the effectiveness of exchange rate risk management in the commercial banking system, it is essential to analyze the relationship between foreign currency trading, credit operations, capital mobilization, and other investment activities Understanding these interconnected areas enables banks to develop comprehensive strategies for mitigating exchange rate fluctuations Effective risk management in these domains enhances financial stability and supports sustainable banking operations in a volatile currency environment.
This research acknowledges that, due to the limitations of the author's experience, it does not address all aspects of exchange rate risk management Future studies are needed to fully explore and develop comprehensive strategies for managing currency exchange risks Ongoing research will continue to build on these findings, contributing to more effective risk mitigation in foreign exchange markets.
Conclusions
This article explores the risk management challenges associated with exchange rate fluctuations in the foreign currency trading operations of the commercial banking system It aims to identify key issues and provide practical recommendations to enhance exchange rate risk management Focusing on the foreign currency trading activities of commercial banks in Ho Chi Minh City, the study offers insights into effective strategies for minimizing financial risks and improving overall risk control measures in the banking sector.
The risk management method for exchange rate fluctuations in commercial banks is more complex than in companies due to the extensive volume of foreign exchange transactions These transactions involve various foreign currencies and different maturities, resulting in receivables and payables in foreign currencies on the banks' balance sheets Consequently, effective exchange rate risk management is crucial for maintaining financial stability and minimizing potential losses in commercial banking operations.
Associate Professor Dr Tran Huy Hoang contributes valuable insights on risk management strategies for exchange rate fluctuations in foreign currency trading within the commercial banking sector in Ho Chi Minh City His research emphasizes the importance of effective risk mitigation approaches to enhance financial stability and optimize currency trading operations This comprehensive study provides practical solutions to address exchange rate risks, supporting banks in maintaining profitability and resilience in dynamic market conditions.
Supervisor: Associate Professor Ph.D Tran Huy Hoang plays a vital role in guiding thesis projects The latest master's thesis is available for download, offering valuable insights into the research topic To access the full thesis, visit the provided email link or contact directly via gmail.com The comprehensive thesis provides in-depth analysis and findings relevant to the field, making it a crucial resource for researchers and students seeking detailed information.
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Introduction to the foreign exchange market
The Viet Nam foreign exchange market (VINAFOREX)
The establishment and growth of Vietnam's foreign exchange market are closely linked to the economic reforms of the late 1980s and early 1990s Since 1991, the development of the foreign exchange center marked a significant milestone in enhancing market stability and efficiency This period was crucial in laying the foundation for Vietnam's integrated and modernized foreign exchange system, supporting economic growth and international trade.
The supervisor for this project is Associate Professor Ph.D Tran Huy Hoang, who provides expert guidance throughout the research process The article discusses recent developments and updates related to download links for thesis proposals and full dissertations For additional resources and the latest academic materials, students are encouraged to contact via email at zg vbhtj mk@gmail.com This comprehensive review aims to support students in their academic pursuits, ensuring they have access to high-quality research content.
With decision no 207/NH-QĐ dated 16/08/1991 issued by SBV regarding to establishment of foreign exchange centre operating as official foreign exchange market for following objectives:
- To establish an official foreign exchange market among commercial banks and economic units
- To assess and measure supply and demand of foreign currency in the market
- To issue official exchange rate between USD and VND
- To prepare initial conditions for establishment of financial market in the future
Between 1994 and 1998, the Foreign Exchange Center in Hanoi and Ho Chi Minh City operated for three years with trading sessions held twice a week, on Tuesdays and Fridays During this period, the center transitioned to establishing an interbank foreign exchange market, marking a significant development in Vietnam’s financial sector This shift facilitated more efficient currency trading and enhanced the functioning of the foreign exchange market across the country.
The Interbank foreign exchange market was established under Decision No 203/NH-QĐ dated September 20, 1994, issued by the Governor of SBV, to create an organized platform for foreign exchange trading among commercial banks and lay the foundation for future foreign exchange market activities This market enables SBV to intervene effectively and implement national monetary policies Initially, before 1998, foreign exchange transactions in Vinaforex primarily consisted of spot transactions, but starting in 1998, forward and swap transactions were officially introduced.
Under the supervision of Associate Professor Ph.D Tran Huy Hoang, the article examines the evolving derivatives market from 1998 to the present, highlighting key developments and trends It provides an in-depth analysis of market dynamics, emphasizing the significance of derivatives in risk management and financial strategy The study explores the growth trajectory of derivatives trading over the years, illustrating its increasing role in global financial markets Additionally, the research discusses the impact of technological advancements and regulatory changes on the derivatives landscape, offering insights into future market prospects This comprehensive review serves as a valuable resource for understanding the historical and current state of the derivatives market.
Forward and swap transactions have been regulated under Decision No 17/QĐ-NHNN7 dated January 10, 1998, which provides guidelines for foreign exchange operations According to these regulations, most commercial banks involved in such transactions negotiate the amount of currency to be paid at a future forward rate within margins set by the State Bank of Vietnam (SBV) Initially, SBV licensed 28 commercial banks—including 21 foreign bank branches and 7 Vietnamese banks (comprising 4 state-owned and 3 joint-stock banks)—to conduct forward and swap transactions Since 1998, a broad range of banks, including state-owned banks, joint-stock banks, joint venture banks, and foreign bank branches, have increasingly engaged in forward and swap foreign exchange transactions.
In 2002 with the approval by SBV, the Eximbank (EIB) experiments with option transactions of strong currencies like EUR, AUD, SGD against USD
Several commercial banks in Ho Chi Minh City, including ACB, VAB, and TCB, received approval from the State Bank of Vietnam (SBV) to conduct option transactions, expanding their trading scope from EUR/USD or AUD/USD to include USD/VND options These transactions also extend to gold options However, SBV issued Decision No 1820/NHNN-QLNH on March 18, 2009, instructing banks to cease USD/VND option trading Additionally, the organization and operation of the VINAFOREX market are closely regulated to ensure stable and transparent foreign exchange activities.
The supervisor for this research is Associate Professor Ph.D Tran Huy Hoang, who provides expert guidance throughout the thesis process The document, authored under his supervision, covers the latest developments and comprehensive insights into the subject matter For further details or to access the full thesis, please contact via email at [provided email address] This research aims to contribute valuable knowledge to the field, ensuring it aligns with current academic and industry standards.
VINAFOREX was established in 1991, coinciding with Vietnam’s transition to a market economy Over the past 18 years, the VINAFOREX market has experienced significant growth in both the scope of activities and the variety of transactions The market has successfully attracted participation from enterprises and commercial banks in both international and domestic sectors, highlighting its vital role in Vietnam’s evolving financial landscape.
Regarding structure and operation of VINAFOREX could be described as model below:
Commercial banks serve as intermediaries in foreign exchange transactions, primarily to meet the needs of clients and enterprises, particularly import-export companies They actively trade foreign currencies on domestic and international interbank markets to achieve profit targets, maintain balanced foreign currency positions, and minimize associated risks.
Exchange rate and risk management of exchange rate….…
Definition of exchange rate
Exchange rate is the price at which one currency is exchanged for another or one currency to be presented by an amount of other currency
Example: 1 USD = 19.000 VND which mean that the price of 1 USD is displayed by amount of 19.000 VND.
Classification of exchange rate
In reality, we usually see some types of exchange rates as follows: a Bid and Offer exchange rate:
Bid rate is a bank buying rate at which banks use to buy a reference currency
Offer rate is a bank selling rate at which banks use to sell a reference currency Bid rate is often preceded and lower than Offer rate
The Citibank quote EUR/USD = 1.4725 – 1.4735 indicates that the bid rate of 1.4725 represents the price at which EUR is sold to buy USD, while the offer rate of 1.4735 reflects the price at which EUR can be bought with USD Understanding spot and forward exchange rates is essential for trading and hedging in the foreign exchange market Spot exchange rates are the current prices for immediate currency transactions, whereas forward rates are agreed-upon prices for currency exchanges scheduled for future dates, helping businesses manage currency risk effectively.
The spot exchange rate is the current exchange rate agreed upon today, but it is settled two working days after the contract is signed In contrast, the forward exchange rate is negotiated today but is settled three working days after the signing of the forward contract Additionally, banknote and transfer exchange rates refer to the rates applied for currency exchanges in cash transactions and electronic transfers, respectively.
Exchange rate of banknotes are listed for cash & cheque
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Transaction exchange rates are used for transactions in the respective currency Typically, banks offer a note buying rate that is lower than the transaction rate, while the note selling rate is usually equal to or higher than the transaction rate Additionally, open and closing rates are important benchmarks that reflect the currency's value during trading hours and at market close.
The open rate is the exchange rate applied at the beginning of the trading day, while the closing rate is used for the final deal of the day Banks typically do not display all exchange rates negotiated throughout the day but generally announce only the closing rate, which reflects the final trading activity These rates are essential for understanding currency value fluctuations and are commonly used for financial reporting and international transactions.
The closing rate is a vital indicator that reflects fluctuations in the foreign exchange market throughout the trading day It is important to note that the closing rate today may differ from the open rate tomorrow, highlighting the dynamic nature of exchange rate movements Additionally, the official exchange rate serves as a benchmark for currency valuation and international transactions.
The official exchange rate, issued by the central bank, represents the value of the domestic currency against foreign currencies This rate is essential for calculating import and export taxes, as well as for various government foreign exchange activities, including short-term, medium-term, and long-term loans.
The official exchange rate, established through the interbank market, serves as the benchmark for commercial banks to set transaction rates within the trading band regulated by the central bank Additionally, the free market exchange rate refers to the rate determined by supply and demand in the open market, often fluctuating based on market conditions and pressure from various economic factors These exchange rates collectively influence the currency trading environment and impact international transactions.
Free market exchange rate is set up depending on supply and demand of foreign currency in the free market g Nominal and Real exchange rate:
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Nominal exchange rate is expressed as a rate between two currencies after taking inflation into account
Real exchange rate is an actual rate of exchange reflecting correlative purchasing power between two currencies h Crossed exchange rate:
Crossed exchange rate is an exchange rate derived from the third currency (intermediate currency) i Fixed and Floating exchange rate:
A fixed exchange rate is maintained by the central bank without fluctuations, requiring continuous intervention to preserve stability Market forces of supply and demand exert pressure on the exchange rate, compelling the central bank to intervene regularly to uphold the fixed rate This constant market intervention ensures currency stability but demands ongoing efforts from the central bank to manage currency value effectively.
Floating exchange rate is set up basing on supply and demand relation in the foreign exchange market, central bank do not need to interfere into foreign exchange market.
Types of foreign exchange transactions
Spot transaction
rate, the value date is the next 2 working days This kind of transactions are popular in Vinaforex market and being carried out by most commercial banks.
Forward transaction
binding obligation to buy or to sell a certain amount of currency at a pre- agreed rate of exchange on a certain future date
Swap transaction
flow of two currencies at periodic intervals over a predetermined period of
In a cross currency swap, there is a physical exchange of principals at maturity, with the equivalent amount based on the initial spot exchange rate, unlike standard interest rate swaps This financial instrument involves swapping currencies, exemplified by scenarios such as converting USD to JPY There are two main types of swap transactions, each serving different hedging and investment purposes.
- Currency swap including spot and forward transaction: conducted at the same time in buying spot transaction and selling forward transaction or vice versa
This kind of currency swap is very popular in foreign exchange market
- Currency swap including two forward transactions: conducted at the same time in buying and selling two forward transactions at a pre-agreed rate of exchange on two different future dates
2.3.4 Future transaction is a contract for specific quantities of given currencies by which the exchange rate is fixed at the time the contract entered into and the delivery date is set by the exchange Actually, Futures contracts are the standardized forward contracts that trade on organized futures markets for specific delivery only Future contract is standardized on kind of currencies traded; size of contract; delivery date using as a hedging tool as well as speculation to take full advantage of foreign exchange rate in consistence with market trends.
Option transaction
Options give the right, but not the obligation, to buy or sell a specific quantity of an underlying asset at a predetermined price by a certain maturity date This also includes the option to buy or sell a specific amount of currency at a set exchange rate on or before a designated future date The buyer of this right typically pays a fixed price, known as the premium, for the option itself.
The article discusses options trading, highlighting that the seller of an option has an obligation to fulfill financial responsibilities if the buyer exercises their right It emphasizes the importance of understanding the contractual commitments involved in premium options trading, where both parties have specific rights and obligations This knowledge is crucial for investors engaging in options to manage risks and ensure proper financial planning.
There are two types of currency options as the following:
- European option can be exercised only on expiry date
- American option can be exercised on or before the expiry date.
Risk management of exchange rate
Definition of risk management of exchange rate
- Risk management is the process consisting in the identification, measurement and control of risks within a level coherent with the risk appetite of the institution
Effective exchange rate risk management in foreign exchange operations involves the identification, measurement, and control of risks associated with currency fluctuations By analyzing potential exposure and implementing strategic measures, businesses can mitigate the impact of exchange rate volatility Utilizing various solutions, such as hedging instruments, helps prevent significant losses from open forex positions, ensuring financial stability and safeguarding profitability amidst foreign exchange market fluctuations.
- Purposes of risk management of exchange rate
+ To protect commercial banks from serious losses without anticipating the worst in foreign exchange operation
+ To prepare for disadvantageous changes of exchange rate towards foreign exchange operations
+ To reduce the sensitive market movements towards foreign exchange operation
+ To strengthen the competitive advantages
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+ To regulate the risk of exchange rate and catch the business opportunities
2.4.2 Factors influencing risk management of exchange rate
International trade involves import and export activities as well as foreign investments, impacting exchange rates An increase in export activities raises the supply of foreign currency, which, all else being equal, can lead to a decrease in the exchange rate Conversely, a surge in import activities increases demand for foreign currency, causing the exchange rate to rise Additionally, higher foreign investment into a host country boosts the supply of foreign currency, leading to a depreciation of the local currency relative to foreign currencies.
The Consumer Price Index (CPI) significantly influences the exchange rate between foreign and local currencies An increase in domestic prices, measured by CPI, makes export goods more expensive and import goods comparatively cheaper, leading to a decrease in the supply of foreign currency and an increase in demand Conversely, a decrease in domestic prices relative to global prices causes the foreign exchange rate to rise, reflecting changes in currency supply and demand driven by price fluctuations.
Interest rates represent the cost of using capital for borrowers, and differences in interest rates across countries can lead to currency cash flow transfers When the real interest rate of a local currency exceeds that of a foreign currency, assets denominated in the local currency become more attractive, prompting cash flows to shift from foreign to local currency assets These interest rate differentials in the forex market drive currency movements and influence international investment flows.
Supervised by Associate Professor Ph.D Tran Huy Hoang, this article discusses how fluctuations in demand and supply influence foreign exchange markets A decrease in demand for foreign currency coupled with an increase in supply can lead to a depreciation of the local currency, while an increase in demand and a decrease in supply can cause appreciation Understanding these dynamics is crucial for analyzing currency value changes and implementing effective monetary policies.
An increase in a country's relative income compared to foreign countries can lead to higher import volumes, as residents demand more foreign goods This heightened demand for foreign products causes the demand for foreign currency to surpass its supply in the forex market Consequently, the local currency depreciates against foreign currencies, resulting in an increased exchange rate and a weaker local currency relative to foreign currencies.
Government policies significantly influence foreign exchange rates through macroeconomic measures that impact inflation, interest rates, and economic growth Additionally, government actions such as protectionism—imposing quotas, tariffs, and taxes—affect the demand and supply of foreign currency by altering product prices, return on assets, and return on equity These policies influence the flow of merchandise and cash across borders, where increased protectionism raises import prices, reduces import volume, and decreases foreign currency demand, leading to currency depreciation Conversely, reduced protectionism can stimulate imports, increase foreign currency demand, and cause local currency appreciation.
Market speculation significantly impacts foreign exchange rates, as speculators' expectations about the future value of a currency drive their trading decisions When they anticipate an increase in a currency's value, they tend to buy foreign currency, influencing exchange rate fluctuations These speculative activities can lead to increased volatility in the foreign exchange market, highlighting the importance of investor sentiment and market expectations in shaping currency trends.
Supervising the research is Associate Professor Ph.D Tran Huy Hoang The study highlights that speculators typically aim to profit from anticipated currency movements by buying foreign currency when they expect prices to fall and selling when prices are expected to rise These speculative activities can lead to significant fluctuations in the foreign exchange rates within the forex market, impacting economic stability and currency valuation.
The psychology of investors plays a crucial role in influencing foreign exchange rates When a large number of investors trust a particular foreign currency, such as the USD, its value tends to increase due to heightened demand Consequently, the exchange rate between USD and VND rises as more investors buy USD, reflecting the impact of investor confidence on currency valuation.
Besides, in the event of political and economic environment changes, affect to supply and demand of foreign currency and cause volatility of foreign exchange rate
2.4.3 Identification of risk of exchange rate
Foreign exchange operations involve significant risks, including interest rate risk, credit risk, settlement risk, technical risk, operational risk, legal and regulatory risk, and country risk Additionally, foreign exchange transactions carry a unique and constant challenge: exchange rate risk Due to the frequent and unpredictable fluctuations in exchange rates, this risk is considered a permanent aspect of foreign exchange activities in commercial banks Proper management of exchange rate risk is crucial to mitigating potential financial losses in foreign exchange operations.
In the foreign exchange operation, there are three basis measures to make profits as follows:
Profits in foreign exchange trading are generated when dealers create and manage foreign exchange positions by buying or selling specific currencies and capitalizing on exchange rate movements By strategically trading off these foreign exchange positions, dealers can realize gains, making profit from fluctuations in currency values This process involves monitoring and anticipating market changes to maximize returns through informed trading decisions.
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Arbitrage involves buying a currency at a lower price in one location and selling it at a higher price elsewhere to earn risk-free profits quickly Since arbitrage traders buy and sell the same currency volume simultaneously, they avoid exchange rate risks by not creating foreign exchange positions This strategy allows for short-term, low-risk profit opportunities in the currency market.
Risk management of exchange rate with Long or short position in
2.4.5 Risk management of exchange rate with Long or short position in net exposure:
Net Exposure (NEi) for a specific foreign currency and duration is defined as the difference between assets and liabilities, combined with the net foreign exchange position for that currency at the same duration This measure helps assess the potential impact of exchange rate fluctuations on an entity's financial position The formula used to calculate NEi provides a clear method to quantify currency risk, enabling better risk management and hedging strategies Understanding net exposure is essential for financial institutions and businesses engaged in international transactions to optimize their foreign currency risk mitigation.
- Ai and Li are asset and liability in foreign currency i
- CLi and CSi are positions of buying or selling currency i
If NEi > 0 when foreign currency i drop in price, bank gets loss of net exposure
If NEi < 0 when foreign currency i raise in price, bank gets loss of net exposure
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Example : ABC bank have transactions with same duration of 3 months as follows:
Buying 3.000.000 USD and selling 4.600.000 USD Lending 3.420.000 USD and mobilizing 3.350.000 USD
= -1.500.000 USD So NE USD < 0 and USD raise in price when it become due after three months ABC bank will get loss of net exposure of USD.
Risk management of exchange rate with Long or Short position in
Banking transactions like mobilization, lending, and currency trading involve various durations and multiple types of currencies, making it complex to determine the net total position of foreign currencies across different timeframes.
Net Total Exposure (NTE) for a foreign currency is defined as the net exposure of all forex transactions adjusted for their respective durations It represents the cumulative impact of currency risks by aggregating individual transactions while considering the time horizon of each This metric provides a comprehensive view of overall currency risk exposure, enabling better risk management and informed decision-making in foreign exchange activities.
- Ri is value of transaction i of term-receivable of foreign currency (such as lending, buying bonds & bill of exchanges, investing in foreign currency and forward buying transactions
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- Pj is value of transaction j of term-payable of foreign currency (such as deposits, issuing bonds & bill of exchanges, receiving foreign investments and forward selling transactions
- D is the averaged duration of all currency transactions
- Ni and Nj is correlative duration of receivables i and payables j (i,j 1,2,3,4…)
If NTE > 0 and foreign currency drop in price, bank gets loss of net total exposure
If NTE < 0 and foreign currency raise the price, bank gets loss of net total exposure
Banks must decide whether to accept open position risk—either positive or negative—by evaluating their exposure to exchange rate fluctuations They have two main options: accepting the open position, which can result in profit or loss depending on currency movements, or utilizing hedging strategies to mitigate exchange rate risk To make informed decisions, banks analyze market trends and predict future exchange rate movements, setting target rates accordingly Additionally, the behavior and risk appetite of bank managers influence their approach to managing currency risk effectively.
To effectively manage exchange rate risk when holding a long (NEi or NTE > 0) or short (NEi or NTE < 0) forex position, banks can implement various risk mitigation strategies These measures include hedging through forward contracts, options, and other derivative instruments to protect against adverse currency movements Additionally, banks may employ currency swaps and diversification techniques to reduce exposure and enhance financial stability Proper risk management ensures minimizing potential losses due to exchange rate volatility, safeguarding banking operations and international trade transactions.
Foreign currency NE i or NTE >0 NE i or NTE