Cross-Currency Settlement Risk

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.

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Finance: How does foreign exchange work?11 Views

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Finance allah shmoop how does foreign exchange work All right

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Well there's risk when you buy and sell goods and

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services outside of the u s that isn't there when

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you buy and sell goods inside the u s your

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smoothies and absence a major chain of a thousand smoothie

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shops you buy a million bananas a year the customers

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believe that they have a peel you buy all of

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them plantains actually these little guys from uganda and just

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agreed to pay in ugandan shillings One u s dollar

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buys about four thousand ugandan shillings and that's a lot

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of bananas You take the risk on the foreign exchange

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currency because well you don't like hedging your bets you're

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just going to take the risk if the currency moves

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up or down it's on you horse at another way

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Yeah if you were nervous about relative currency valuation fluctuations

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well you could be a kind of currency life insurance

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in paying a ten or twenty percent premium above where

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the relative currencies air trading today that for thousands of

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one thing and you could sleep pretty well at night

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knowing that your rates were fixed like you're basically paying

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Someone else to take the risk of uganda suddenly getting

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its financial act together in its currency skyrocketing so that

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a u s dollars only buys you three thousand or

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two thousand ugandan shillings or things go the other way

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But you don't like buying insurance You know how nice

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the jets are that insurance executives fly and you know

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about warren buffett He didn't get there for free so

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you didn't had you didn't do anything to worry about

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currency but then all of a sudden china decides to

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adopt uganda as its new financial partner agreeing toe underwrite

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all of uganda's debts basically in return for well uganda

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Yeah they liked owning uganda way better weather and they

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also got the highly prized you r l uganda dot

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com So then almost literally overnight the ugandan shilling becomes

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highly more valued under the deeply respected and feared auspices

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of the chinese banking system So instead of a dollar

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buying you for thousand schillings while now a u s

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dollar only buys you one thousand so your cost of

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bananas just went from four hundred bucks a ton to

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sixteen hundred bucks and the marginal cost of those banana

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Plantain Things in your shakes went from thirty cents over

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a dollar twenty and with profit margin per shake it

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only two fifty to start with twelve new profit margins

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suddenly dropped almost in half Eventually you'll have to find

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another banana supplier or raise prices or figure out a

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substitute But well for now it looks like this Foreign 00:02:29.253 --> [endTime] exchange deals Profits will get eating

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