Cross-Currency Settlement Risk
Categories: Forex, International, Trading
In the wild and wooly world of buying and selling foreign currency, there is always the risk that one would purchase and pay for a particular currency, but not receive the currency he or she is buying at the exact same time.
For example, a U.S. bank might pay $20 million for British pounds, but due to different time zones, the bank may not receive the pounds at the exact same time. The currency can move a meaningful amount in that time period, such that, by the time the transaction settles legally…somebody has lost money.
Time really is money.
Related or Semi-related Video
Finance: How does foreign exchange work?11 Views
Finance allah shmoop how does foreign exchange work All right
Well there's risk when you buy and sell goods and
services outside of the u s that isn't there when
you buy and sell goods inside the u s your
smoothies and absence a major chain of a thousand smoothie
shops you buy a million bananas a year the customers
believe that they have a peel you buy all of
them plantains actually these little guys from uganda and just
agreed to pay in ugandan shillings One u s dollar
buys about four thousand ugandan shillings and that's a lot
of bananas You take the risk on the foreign exchange
currency because well you don't like hedging your bets you're
just going to take the risk if the currency moves
up or down it's on you horse at another way
Yeah if you were nervous about relative currency valuation fluctuations
well you could be a kind of currency life insurance
in paying a ten or twenty percent premium above where
the relative currencies air trading today that for thousands of
one thing and you could sleep pretty well at night
knowing that your rates were fixed like you're basically paying
Someone else to take the risk of uganda suddenly getting
its financial act together in its currency skyrocketing so that
a u s dollars only buys you three thousand or
two thousand ugandan shillings or things go the other way
But you don't like buying insurance You know how nice
the jets are that insurance executives fly and you know
about warren buffett He didn't get there for free so
you didn't had you didn't do anything to worry about
currency but then all of a sudden china decides to
adopt uganda as its new financial partner agreeing toe underwrite
all of uganda's debts basically in return for well uganda
Yeah they liked owning uganda way better weather and they
also got the highly prized you r l uganda dot
com So then almost literally overnight the ugandan shilling becomes
highly more valued under the deeply respected and feared auspices
of the chinese banking system So instead of a dollar
buying you for thousand schillings while now a u s
dollar only buys you one thousand so your cost of
bananas just went from four hundred bucks a ton to
sixteen hundred bucks and the marginal cost of those banana
Plantain Things in your shakes went from thirty cents over
a dollar twenty and with profit margin per shake it
only two fifty to start with twelve new profit margins
suddenly dropped almost in half Eventually you'll have to find
another banana supplier or raise prices or figure out a
substitute But well for now it looks like this Foreign 00:02:29.253 --> [endTime] exchange deals Profits will get eating