The paper "Analysis of Foreign Exchange Market Risks" is a wonderful example of a literature review on macro and microeconomics. According to Fama, E. (May 1970: 383-417) financial institutions are faced with a wide array of financial risks. Examples of financial risks include credit risk (Flood, R.P. and Garber, P.M. , 1982), interest rate risk, liquidity risk, foreign exchange risk, and political risk. This essay reports on credit risk, political risk, and liquidity risk and how financial institutions that have interests in foreign exchange markets determine quality in order to minimize risks.
It looks at the implication of credit risk, political risk, and liquidity risk. It looks into factors that control each risk and measures that are adopted to reduce the magnitude of each risk. The objectives of risk assessment of a financial institution are first, to enable the financial institution to assess and aggregate credit data across disparate systems and sources. Second to enable the financial institution to integrate credit scoring and internal rating with credit portfolio risk assessment. Third, enables a financial institution to accurately forecast measure, monitor, and report potential risk exposures across the firm’ s counterparty and portfolio level.
Fourthly, to enable the financial institutions to evaluate substitute strategies for pricing, hedging, and transferring credit risk. Fifth, to enable a financial institutions to ensure it satisfies regulatory compliance and risk disclosure requirements. Gloria, M.S. (2004: 1089-1110) suggested that credit risk is a measurable future default likelihood in terms of credit score or credit scorecard or credit analysis that reflects credit quality or creditworthiness subject to obligor’ s or credit’ s ability to satisfy its obligation. Gloria, M.S. added that financial institutions evaluate credit quality depending on the type of credit risk in question or form of credit risk.
Fama, E. (1970:383-417) and Gloria, M.S. (2004:1089-1110) reported the existence of different types of credit risks namely individual credit risk, sovereign government credit risk, bank loans, or derivative transactions. De Servigny (2004) proposed that financial institution assesses credit risk by evaluating three core factors. These factors that are used as measures of creditworthiness are default probability, credit exposure, and recovery rate.
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