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Part 3: Nostro/Vostro Accounts, Forex Exposures & Hedging

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Part 3: Nostro/Vostro Accounts, Forex Exposures & Hedging

Series: Understanding the Foreign Exchange (Forex) Market

9. Nostro, Vostro & Loro Accounts

  • Nostro Account: "Our account with you" – A domestic bank’s account held in a foreign bank.
    Example: SBI holds a USD account in Citibank, New York – this is SBI’s Nostro account.
  • Vostro Account: "Your account with us" – A foreign bank’s account held in the domestic bank.
    Example: Citibank’s INR account held with SBI – this is SBI’s Vostro account.
  • Loro Account: "Their account with them" – A third-party bank’s account seen from another bank’s perspective.
    Example: ICICI refers to SBI’s account with HSBC as a Loro account.

10. Types of Forex Exposures

  • Transaction Exposure: Risk from actual foreign currency transactions (receivables/payables).
    Example: An Indian firm exporting goods to the US has USD receivables – risk arises from USD/INR movement.
  • Translation Exposure: Risk from converting foreign operations into home currency for accounting.
    Example: MNCs translating US subsidiary's assets into INR for consolidated financials.
  • Economic Exposure: Long-term impact on firm’s cash flows and market value due to currency changes.
    Example: A firm sourcing raw materials from abroad faces profitability issues if the home currency weakens.

11. How to Hedge Forex Risk

  • Forward Contracts: Agreement to exchange currency at a future date at a fixed rate.
    Example: Exporter agrees to sell USD at ₹83.50 after 3 months.
  • Options: Right (not obligation) to buy/sell currency at a fixed rate.
    Example: Importer buys a call option to purchase USD at ₹84, limiting risk.
  • Currency Swaps: Exchange of principal and interest in different currencies.
    Example: An Indian firm swaps its INR loan interest with a US firm’s USD loan.
  • Natural Hedge: Matching inflows and outflows in the same currency.
    Example: A company that imports from the US and also exports to the US offsets the currency risk.
  • Money Market Hedge: Involves borrowing/lending in foreign currency to cover future flows.
    Example: Firm borrows USD now to repay a USD obligation due in 90 days.

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