8/14/2019 eforex stp

1/2

68 april 2003 e -FOREX april 2003 e -FOREX 69

In a world where currency traders, portfolio managers and

corporate treasurers are pursuing ever more sophisticated

investment strategies, it is becoming increasingly difficult to

properly assess the true risk profile of certain positions. This is

especially true in the forex trading market where complex

products such as path-dependent barrier options are used to

establish direction trades or when the underlying currency

exposure arises from a position in multifaceted products such

as structured notes or convertible bonds.

Investors historically have analyzed their currency exposure in

isolation and under simplistic assumptions with respect to the

timing and magnitude of the expected cash flows they are

trying to hedge. As a result, hedging currency exposure usually

entailed assessing par value or nominal currency exposure

and subsequently hedging the portion deemed unacceptable

using plain-vanilla currency options or foreign-exchange

futures. This practice is however often sub-optimal because it

fails to account for the natural diversification occurring between

different sources of risks embedded in a portfolio. Also, it fails

to account for the fact that portfolio managers and treasurers

usually want to mitigate their downside risk (potential losses)

and not necessary eliminate their currency exposure. A new

approach allowing better identification of the risks supported is

undoubtedly needed.

For instance, before hedging a portfolio for its currency risk,

portfolio managers may want to identify and segregate their

exposure to specific movements in interest rates, credit spreads

and foreign exchange rates. Different conditional-expectations

scenarios can then be applied to assess the true amount of

downside risk actually faced by the investors. Ultimately, only

the exposure deemed unacceptable should be hedged using

custom-made and cost-effective derivative products such as

credit and currency derivatives. The emergence of specialized

products such as credit default swaps, total return swaps and

credit spread options enables portfolio managers to eliminate or

mitigate credit risk exposures, while currency derivatives such

as vanilla or complex FX options allows them to alter their

currency exposure.

..monitoring currencyexposure requires a

sophisticated risk engine

In other words, the presence of tailored products allows

investors to neutralize very specific exposure. This, coupledwith the ability to segregate sources of risk with greater

granularity, will undoubtedly lead to the use of more

meaningful, effective, and tailored hedging strategies, especially

in liquid markets such as the currency market. However,

complex and tailored hedging strategies must be supported by

appropriate analytical tools to assess risk and return in order to

fulfill their true potential.

In todays world, monitoring currency exposure requires a

sophisticated risk engine capable of supporting complex

derivative products, of analyzing aggregated portfolio exposures

across several dimensions, and of conducting horizon analysis

in a consistent manner. However, sophisticated risk systems

have historically been costly and difficult to maintain.

>>>

Straight-throughprocessing for Forex

More importantly, they were difficult to use, lacked flexibility

and were for the most part, fairly unintuitive. This created asituation where only very few managers could own such a risk

system; and even fewer could use the technology to its fullest

potential. There is no doubt that the inability of portfolio

managers to properly assess the true risk profile of their

positions and the true impact of certain derivative products has

hindered growth in the currency derivative trading area.

Portfolio managers will only invest in complex products once

they fully understand the risk profile and profit enhancement

capabilities of those products.

This is why certain risk providers have invested millions of

dollars developing a new suite of risk management products

that are better suited for complex trading and enhanced

usability.

These products were specifically designed to support non-linear

products such as options and convertible bonds. But the mainarea where these products really distinguish themselves is that

they can be fully embedded within a trading platform. This

approach completely removes implementation risk, reduces

maintenance cost, enhances security and facilitates data

reconciliation. Most importantly, it allows investors to conduct

truly real-time risk analysis and what-if scenarios on their

positions.

But reducing failure ratesis not the only focus for

risk managers

Pre-trade market risk analysisin e-forex platforms

8/14/2019 eforex stp

2/2

Another key benefit of embedding sophisticated risk managementtools within a trading platform is that it significantly mitigates

operational risk. This is achieved by reducing the amount of data

transferred from one system to another and aligns the middle office

with the front office. Since both the analysis and execution are

handled by one system, there is effectively a greater control over data

flow and lower likelihood of costly operational failures. But reducing

failure rates is not the only focus for risk managers in a business

environment.

Indeed, for banks, a key measure of competitive advantage and

business effectiveness is use of capital in risk trading areas. And

increasingly, it is not just market and credit risk that must be factored

into costs and pricing, but also operational risk. Errors in processing

deals at regulated financial institutions will in the future have a capital

implication. This must be modeled within the overall risk management

environment, in particular if the organization is to calculate the truereturn on economic capital invested in the forex business.

With currencies swinging up and down at a dizzying pace and financial

markets reacting more vividly to economic news, investors are facing

unprecedented portfolio volatility. If history is any guide, this volatility

is here to stay and will fundamentally change the nature of investment

strategies undertaken by professional investors and corporate

treasurers. With new and more complex strategies comes the need forequally powerful risk measurement and management systems that

truly capture the total risk undertaken by an investor. Whether an

investor is facing market, credit or operational risks, these risk must be

well understood, quantified and managed. And the trading platform is

the logical place to do so in an integrated and efficient way.

Straight-through processing for Forex

Benoit Fleury.Director, Algorithmics Bloomberg Solutions

with contributions from David Syerand Andrew Aziz