Settlement Risk

Settlement risk occurs because of the difference of time zones on different continents. Consequently, currencies may be traded at different prices at different times during the trading day. Australian and New Zealand Dollars are credited first, then the Japanese Yen, followed by the European currencies and ending with the US Dollar. Therefore, payment may be made to a party that will declare insolvency or be declared insolvent, prior to that party executing its own payments.

In assessing credit risk, the trader must consider not only the market value of their currency portfolios, but also the potential exposure of these portfolios.

The potential exposure may be determined through probability analysis over the time to maturity of the outstanding position. The computerized systems currently available are very useful in implementing credit risk policies. Credit lines are easily monitored. In addition, the matching systems introduced in foreign exchange since April 1993, are used by traders for credit policy implementation as well. Traders input the total line of credit for a specific counter-party. During the trading session, the line of credit is automatically adjusted. If the line is fully used, the system will prevent the trader from further dealing with that counter-party. After maturity, the credit line reverts to its original level.

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