Role Of Benchmarking In Foreign Exchange Risks

Foreign Exchange Markets, as we know, experience natural price and volume fluctuations because of the dynamic forces of demand and supply forces working behind them. There is a need to evaluate both the risk consequences and measuring the performance while trading. Benchmarking in foreign exchange risks help as being the yardsticks to assess performance and risk exposure against a unit's goals. The need for benchmarks in foreign exchange markets is particularly widespread as currency exposure needs to be monitored and measured carefully.

Benchmarking in forex risks has increased in importance as rates at which transactions are actually executed. Transacting at any rate lower than the measured benchmark usually results in a visible loss immediately. Benchmark rates in foreign exchange are gaining popularity because of their value as a transparent and fair reflection of a market.

Which benchmarks in foreign exchange should a client use? Generally, the most preferred benchmarks are those which provide a transparent and unbiased rate, which is s also cost-efficient. They are a true representative of the market they reflect. As a transparent process always inspires trust and confidence, these benchmark rates are also easy to execute.

Benchmarking in foreign exchange risks typically requires clients to submit orders to their executing banks ahead of time in order to transact against that particular fixing. The banks are then responsible to act on behalf of the client. Buying and selling the currency at the time of that fixing to match the fixing rate minus the cost of execution is the bank is the responsibility of the bank traders.

This practice of using benchmarks in foreign exchange has developed some issues of its own. For instance, a currency portfolio manager might be content to execute at that benchmark rate even if the execution flows adversely affects the benchmark rate itself. Although showing zero tracking error, there is actually less value received for the transaction.

Some clients resolve this problem by taking different approaches. Some buy or sell themselves around the fixing. Another strategy is to ask a bank trader to minimize costs by trading around the fix using inter-dealer liquidity.