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.

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.

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.