Internal audit roles and responsibilities A baseline definition of internal auditing provides a starting point for understanding the

roles and responsibilities of internal audit function. The Institute of Internal Auditors ("IIA") offers the following description: "Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organisation's operations. It helps an organisation accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes." Major roles and responsibilities of internal audit function are summarised as below: evaluates and provides reasonable assurance that risk management, control, and governance systems are functioning as intended and will enable the organisation's objectives and goals to be met reports risk management issues and internal controls deficiencies identified directly to the audit committee and provides recommendations for improving the organisation's operations, in terms of both efficient and effective performance evaluates information security and associated risk exposures evaluates regulatory compliance program with consultation from legal counsel evaluates the organisation's readiness in case of business interruption maintains open communication with management and the audit committee teams with other internal and external resources as appropriate engages in continuous education and staff development provides support to the company's anti-fraud programs.

Reporting Structure of Internal Audit Function Existing corporate governance regulations do not address the interaction between the audit committee and the internal audit function, or the responsibilities of the function. In most companies, the internal auditor traditionally reported to either the Chief Financial Officer or the Chief Risk Officer, though other may have existed in some companies. Today, the internal auditor may either report directly to the Audit Committee, or the Audit Committee will have a role in hiring, firing, evaluating and compensating the Chief Audit Officer. The Audit Committees increasing role with regard to the internal audit is being undertaken to help ensure the internal auditors "independence" and objectivity. The relationship between the Audit Committee and the internal audit function should be clearly defined and addressed in the Audit Committees charter. Authoritative Guidance The Institute of Internal Auditors ("IIA"): Organizational Governance - Guidance for Internal Auditors By providing assurance on the risk management, control, and governance processes within an organisation, internal auditing is one of the key cornerstones of effective organisational governance. The guidance was issued by IIA and it was designed to help internal auditing in its assurance and advisory role with regard to specific aspects of organisational governance. This guidance is available at http://www.theiia.org/ under the "Professional Guidance / Standards and Practices / Position Papers & Responses / View Position Papers" section. The Institute of Internal Auditors Internal Audit Reporting Relationships Serving Two Masters ("IIA"):

This report is based on research developed under the leadership of The IIA Research Foundation and the Research Department of The Institute of Internal Auditors. It reviews the reporting relationships of the chief audit executive as an integral part of the governance process. This report is available at http://www.theiia.org/ under the "Research Foundation / Research Reports / Chronological Listing Research Reports" section. The Institute of Internal Auditors ("IIA"): Sample Internal Audit Department Charter The purpose, authority, and responsibility of the internal audit activity should be defined in a charter. A sample of Internal Audit Department Charter is available at http://www.theiia.org/under the "Professional Guidance / Standards and Practices / Additional Resources / Audit Committees & Board of Directors / Sample Charters" section. The role of insurers internal auditors Internal audit plays a crucial role in testing risk governance and control systems within insurance companies. But this valuable contribution is only just starting to be fully recognised. If you want the best sports car one that will get you round the track fastest and most safely you dont economise on the brakes. The same is true of internal audit. Insurance and other financial services firms that have effective risk management and internal control processes will find it much easier to navigate the tough economic and regulatory environment than those that dont. And just as it is only in bad conditions that you find out how well your brakes work, so risk, governance and control systems are only properly tested when risks crystallise into events that need to be managed. There has been no shortage of opportunities for insurers to put this into practice in recent years. Volatile financial markets, new prudential and conduct-of-business regulation, general insurance claims inaction and increasingly intensive regulatory scrutiny all demand independent assessment of risk management and control capabilities. It is at times like these that internal audit can be most valuable. This is an opportunity that can be viewed as three broad challenges: improving the focus of internal audit activities; firming up external stakeholder relations; and creating the structure and capabilities needed by auditors to operate effectively. Focus of Activities In the wake of business failure, the most common criticism of internal audit is that it has not been sufficiently focused on the right issues. This is the case whether the failure is industry-wide, affects one business, one function or is control-specific. Hindsight is a wonderful thing. However, internal audit must challenge how it chooses what to focus on. Reliance on a primarily coverage-driven methodology, which prioritises completeness over focus, appears increasingly outdated. A more relevant approach is for internal audit to Focus on the issues associated with delivering Sustainable value to shareholders, customers and employees. These include financial strength and resilience, treating customers fairly, and regulatory and legal obligations. In doing so, more attention is directed on the control environment surrounding the commercial and corporate decisions taken by the organisation. It also concentrates the allocation of audit effort on the risks managers face as they deliver the business objectives underlying these decisions. _is in turn leads to more focused priorities for internal audit, aligned to the way the board and executive directors manage the business. It establishes a process that can be responsive to change, increasing the relevance of internal audits output.

External Stakeholder Relations The role of internal audit in relation to external stakeholders has historically been opaque compared with its direct reporting lines to internal stakeholders such as the audit and risk committees. This is partly a result of the minimal legal, regulatory and associated public disclosure requirements of internal audit. Three factors Solvency II, the on-going financial crisis and the new regulatory approach of the FSA are changing all this. Solvency II clearly focuses on risk management, process and control as an integral part of the management of a business. This goes much further than producing numeric information relating to the quantification of required versus actual economic capital. The need for and role of internal audit is an explicit part of the Solvency II regulations, elevating the function s mandate beyond that set out in existing guidance such as the Combined Code. The role of poor risk management and control, and its contribution to business failure, is in the spotlight. In the insurance industry there is increasing emphasis on controls from rating agencies and regulators in addition to Solvency II requirements. Insurers must now be able to point to effective internal control mechanisms and, vitally, to demonstrate where and how these have been effective. Finally, internal audit has become a much greater focus of attention for the FSA as part of its intensive and intrusive new regulatory approach. Each of these factors should be seen as providing a fantastic opportunity for internal audit. It has given the function a more explicit mandate, placed effective risk management and control at the centre of insurance companies agendas, and created a relationship with the FSA that can be used to the benefit of all parties. Structure and Capability All internal audit functions must develop an effective organisational structure focusing on audit delivery (product, process and tone), stakeholder and people management. There are, however, pressing and interrelated challenges facing internal auditors in the insurance industry. The first is strategic positioning and organisational capability. Most insurance companies have invested significantly in risk management frameworks recently, which has led to a wider adoption of the three lines of defence model frontline management, risk management and internal audit. There is now a clearer distinction between each line and a much more formidable second line. This is a good thing for internal audit. It should allow the function to focus strategically on the overall system of governance and control, including testing the effectiveness of risk management. But this broader remit requires internal audit functions to reassess their capabilities and skills many are still more suited to working at a highly detailed level. They must also develop their strategic positioning with internal and external stakeholders. This takes time and much effort and may require budget, at least in transition, none of which is easy to come by at present. The second challenge is internal audits positioning alongside risk management, followin g insurance companies investment in these capabilities. _ere is a need to reassess the alignment of structure, approach, methodology and output of assurance activity between the risk management and internal audit functions. Integrated assurance in a holistic sense is difficult to achieve. However, a more explicit and robust risk management framework within companies across the industry provides a basis for internal audit to take practical steps to align. Failure to grasp this nettle represents a strategic threat to the effectiveness of any internal audit function. Grasping the Opportunity There is no doubt that the insurance industry is experiencing a challenging period of significant change. However, this is exactly the time when internal audit should be most valuable. Promoting effective controls, independently challenging managements assertions and assessing the effectiveness of an insurance companys risk management function are all firmly in the spotlight.

These are the key responsibilities of any organisations board and its audit and risk committees. More strikingly, they are all areas in which an effective internal audit function can contribute in a substantial and meaningful way.

Insurance industry is business on risk, the life insurance company also facing the huge risk in conduct process any time because of undertaking the responsibility of long-term funds benefit, the operation of a huge sum of funds. For such a company that takes risk as the conduct object, guarding and controlling ability of the risk is the main factor foe company to obtain the public trust, take long-term and steady business. Therefore, the life insurance company even should value the usefulness and perfecting of the internal control system, having the necessity to depend on the forerunner and scientific the internal audit system against the risk. This paper puts forward some advice on problems of the current internal audit system of the life insurance company on foundation of analyzing the aim and the function of the internal audit system of the life insurance company. Keywords: life insurance companiesinternal auditinternal control system (A) accounting systems As financial institutions, life insurance companies track business operation is a lot of currency transactions and mass movement of funds. Save numerous accounting system of the trading path became the focus of internal audit and the primary audit object. Before the audit, you must first determine what kind of company accounting system to provide signs, such as coding, cross indexing or connection account balance with written information for the original transaction data. Life insurance company currently trading track may be applied more generally in policy-based, with a policy number to string all transactions associated with them. Work of the Tribunal officers if found in the accounting system to provide track does not meet the audit requirements, accounting and other related departments should be assisted to improve it. With the rise of customer financial management, according to the policy trajectory has failed to complete and clear distinction between transactions reflect customers contact the companys financial, trading based on specific customer accounting system of the future direction of trajectory is a life insurance company. (B) business practice for Day-to-day operations of the business practice for life insurance company is a custom system and provisions, is a company operating guidance document, bringing together the companys many years of experience and lessons learned. Reasonable business rules must be based on compliance with regulatory requirements and market requirements of the business. Life insurance company because the business is a long-term business, often the validity of an insurance contract for dozens of years. Thus typically occurs within the company at the same time there are multiple different versions of business processes in the job, depending on the operation object to determine which process to use. Internal audit personnel must be aware of this. In General, the same applies business rules for insurance contracts should be stable and consistent, but also cannot be generalized. When it finds a business when there are systematic or widespread problems, it should review procedures should be improved. (C) operation record Operation record refers to the life insurance business operations and save documents, vouchers and used in the worksheet, is written track of business processes. Through its

audit, internal audit personnel to recover the actual business operation, and may make the corresponding evaluation. Due to the extensive application of information technology in the life insurance industry, operation record is changed from traditional paper format to electronic format. Efficacy, safety of operation records in electronic format and level of acceptable, has increasingly become a Tribunal required special attention in the content, becoming an important aspect of modern life insurance companys internal audit. Second, the function of internal audit in corporate governance risks, control of life insurance After China joins the WTO, more life insurance market highlights the characteristics of the characteristics of a market economy and fair competition, it entails new life insurance company in accordance with market rules to speed up institutional reform, promote scientific management, to benefit operation. Internal audit function of inspection, identification, evaluation, and construction of these played a role in other audit oversight bodies were difficult to achieve. (A) the internal audit has a direct role in prevent insurance risks Life insurance is a business risk and special industry, life insurance is a risk transfer mechanism, whose basic function is to provide protection. With the advent of the information age, increasingly diversified and complex external environmental risk factors, identify, measure, manage new risk becomes the external environment for new demand for life insurance companies. The other hand, many life insurance companies are far from out of the extensive management strategy, nuclear insurance indemnity is not strict enough, scientific, financial and capital operation is not in accordance with the legal requirements, these are not adapted to the requirements of the WTO to business brought more life insurance company, the greater the risk. Life insurance company to ensure reasonable living and effective development in the new environment, preventing risks is important. Internal audit in prevention risk aspects of role performance in, a is internal audit through check the business activities of legitimacy and the hop Board sexual, timely found deviated from regulations and supervision measures of problem, guarantee business operating activities in regulations and supervision measures allows range within for, reduce business operating risk; II is internal audit through evaluation life insurance company of internal control system, and management system, and various articles of rationality, and complete sexual and validity, find which of management defects and control weaknesses, prevention because lack control and produced of risk; three is internal audit through on financial data for daily monitoring, timely found strange situation, prevent financial risk. (B) internal audit role in the improvement of the life insurance company on the management level with support Life insurance companies, internal audits play a familiar feature of business links, stand in the position of the independent, objective, in front of the planning, decision making, analysis and assessment of programme feasibility, reasonableness, and early in the implementation of plans and decisions, for investigation, discover problems in implementation, feedback to decision-makers, amendments to planning, decision-making, and provide a basis for improvement. Internal audit also can assist managers to identify a branch of the Attorney (responsible person) should take economic responsibility (such as business, profit indicators, and so on) completing the quantity and quality and ensure the effective allocation of resources. Upgrade the management level, the aim is to enhance economic efficiency. Life insurance company internal audit through financial audit, and statistics audit, and economic activities

full process audit, project, find management Shang of problem, and and was audit object common analysis errors and problem of actual and the potential of effect, mining management potential, find human, and material, and financial most reasonable of using way, acts as a operating management personnel strengthening internal control, and perfect operating management, and completed by negative economic responsibility of staff and Assistant, assist leadership improve economic management activities of efficiency, and effect and economic sexual. (C) on the reform of the internal audit in asset restructuring, with the escort role Insurance market competition after entry into WTO is also a life insurance company capital strength contest. Under pressure from the progressive liberalization of the insurance industry, many life insurance companies to expand capital strength as one of the strategic measures to improve the core competitiveness, frequent contacts with international insurance Consortium and the marriage. While the State -owned life insurance companies to adapt to market developments, trying to seek a breakthrough time of existing management system, take the road of joint-stock system reform and listing management. Assets of the insurance industry will soon become a common phenomenon, increasingly important tasks of the preservation of the assets of shareholders when needed reforms, development of internal audit for life insurance companies. In the process of reorganization of assets, monitor assets security, integrity is particularly important. Prior involvement of the internal audit, can thoroughly verify your assets in the account, verify the authenticity of the asset, while or outside qingzhang quantity and value of the assets, strict management, prevent loss of assets outside of the account in the restructuring process. And internal audit process involved, you can stop the extravagance and waste, reduce the cost of restructuring. In addition, the enterprise after restructuring, will involve some promotion and appointment of managers, on the implementation of economic responsibility auditing, with managers responsible and accountable to the shareholders of principles, identify the business condition, financial situation and assets appreciation, we can ensure the efficient use of resources, assets security and compliance, responsible for the protection of the legitimate rights and interests. Third, the problems in the life insurance companys internal audit As life insurance companies operating in China: establishment, significantly strengthening internal audit, to guard against managing risk, incident prevention, legal compliance management plays a great role. However, in practice, due to the failure of some life insurance companies internal audit work as fundamental and important means of management attention, cause there are some weaknesses in the internal audit, the companys management has been restricted. (A) insufficient rights and independence of internal audit Independence of internal audit bodies in form and in substance, impact on internal audit work is enormous. Closed chain lies in its independence of the audit work intensity, size, independence of the audit determines the scope of its functions and effects. Heads of most life insurance companies in China have no direct leadership or special attention to the work of the internal audit unit, up to an Executive Vice President in charge of auditing work. And the internal audit department is responsible on the Board and not the Manager, internal audit departments can not execute under interference in the management of delegated

tasks, can freely report audit findings and evaluations, not subject to interference in the management of, and internal communications. (B) audit concept behind, biased and supervision after the financial supervision A long time, the life insurance companys internal audit focused mainly on financial audit on the review, most of the focus to the verification of the authenticity and legality of financial data; primary function is the error-checking analysis on prevention rather than on business management, evaluation and management recommendations. Financial accounts audit cannot be on the companys management and internal controls and risks in decision making for effective monitoring, cannot increase company value, role of helping management achieve goals. Supervision after serious delays, cannot adapt to the needs of healthy and sound development of the company. Supervision after the verification is formed on the risk of loss, even if the monitoring and effective, the company also suffered major losses in most cases is irreparable. (C) the audit approach and audit technology Currently many life insurance company of internal audit basically is accounts Foundation audit, to all business and accounts for Foundation, main used more audit or rely on Yu audit who personal experience judgment of sampling audit method, and not international Shang advanced of passage of risk Foundation audit, this on makes internal audit randomness is large, lack scientific, audit of content full with audit personnel of experience judgment, caused audit period long, and audit cost commercial, and audit efficiency low. (D) weakness of internal audit, oversight capacity is limited Life insurance companys prevailing weakness of internal audit, leading audit discontinuous, narrow and long interval time of the audit, unable to discover and expose problems and risks of life insurance company business activities, weakening the oversight role of audit. Integrated internal audit personnel quality is not high on the one hand, business is not strong cannot meet the needs of tasks completed internal audit under new situation; on the other hand has no defined employment criteria and assessment mechanisms, internal audit staff requirements is not clear, mobility is more random, and difficult to maintain quality of the internal audit team. Four life insurance company, strengthening of the internal audit strategy Internal audit is a product of further perfecting modern enterprise system, it roots in the enterprise, familiar with the operation and management of the enterprises where conditions and each operation, external audit, its area of work even greater, richer, more diverse, the effect is more apparent. For life insurance company, a risk, but also to continuously improve the companys internal audit. (A) establish a system to meet business needs of the internal audit Sound and regulate the system of internal audit is an audit work a strong support of the progress and implementation of specific measures. Building a system of internal audit is required to guarantee the effective expansion of internal audit. These systems to include audit policies, of the Charter of the audit, audit management, and technical and methodological aspects of the provisions of the various project items such as audit specification. (B) the reorientation of the auditing Department

One of the trends of modern internal audit is to maintain the independence of the Audit Department, making it separate to take your board or the Audit Committee, and to maintain effective communication with the management, under separate management set the auditing Department, responsible to the management, in order to facilitate their independent monitoring function of. (C) establishing a monitoring, evaluation, and recommends that the audit function of integration system Will supervision harbour a management among, implementation internal audit from supervision type to service type of change, and from dispersed management to concentrated management of change, and from experience oriented to risk oriented change, and engaged in Hou audit to thing in the prior audit of change, and from static evaluation to dynamic evaluation of change, and from single angle concern to more angle concern change, and from was audit units passive accept audit to active participation audit change, and from to economic responsibility audit for gravity to full audit change, and audit personnel from single knowledge structure to composite knowledge structure change, and from recalled history to look future of change. (D) to promote the company established a complete set of internal control evaluation system Complete evaluation of internal control system is a prerequisite for to really implement the reform of Auditors. Established internal control evaluation system, a is through on company internal control for diagnosis, find corresponding of risk point, II is depicting out company system tree shaped and units matrix internal control flowchart, for prepared internal control manual, and internal control audit guide do prepared, three is under levels company operations of status carried out management thesis, to improve accounting data of authenticity, and accuracy and integrity, improve system levels company of management level. (E) construction of a high-quality internal audit team Building a high-quality internal audit team are important organizational guarantee of internal audit work to progress. Modern business requires that the internal auditor should be expert in one of the compound-type talents. Auditing requires more than finance experts and information system audit specialist accounting experts, financial regulations, and so on. Audit staff must have sufficient to carry out its task of accounting, economics, management science, law and computer knowledge of necessary knowledge, skills and expertise, and with an independent collection, analysis, evaluation, and the ability to record information. To accomplish this goal, first of all to establish a scientific and practical training mechanisms. One is to strengthen the adaptability to new recruitment, on-the-job staff training. Second, strengthen training for in-service personnel audit and update knowledge and specialized business training under special work to be done. Secondly, actively bring in talent from outside the company. Finally, establish internal mechanisms for the Exchange, attract other Department personnel to audit departmental learning exercises. Procedures and techniques are important in the auditing process. Audit procedures and techniques provide specialists with a variety of tools to assess a business entity's operating environment. An Internal auditor uses such tools to ensure that controls, processes and policies are adequate and effective, and that they adhere to industry practices and regulatory mandates. An internal auditor also checks a corporation's financial statements to ensure that such reports are prepared in accordance with generally accepted accounting principles.

1. Operating Environment o An internal auditor determines how a company operates by asking segment or departmental employees, external auditors, accounting managers, human resources staff and risk specialists. A firm's operating environment describes management's ethical qualities, leadership style and business practices. An internal auditor also could determine how a corporation operates by evaluating industry trends and regulations. For example, an auditor may read a finance publication to understand how banks, insurance companies and hedge funds operate. Review Controls o An internal auditor determines how a company's segment or departmental controls operate by reading prior audit reports or working papers and by inquiring from segment employees who perform such controls on a regular basis. An auditor applies generally accepted auditing standards (GAAS) to detect mechanisms, procedures, tools and methodologies that build controls. Such procedures may be easy or difficult to understand. An internal auditor could ask departmental experts or external consultants to explain complex procedures. Test Controls o An internal auditor tests a business organization's controls, policies and guidelines to ensure that such controls are adequately designed and are operating effectively. Controls are mechanisms and methodologies a corporation's management puts into place to prevent losses due to error, fraud, theft or breaks in technology systems. Effective controls remedy deficiencies and problems properly. Controls are adequate if they provide detailed step-bystep procedures and guidelines for task performance, decision-making processes and lines of hierarchy. Account Balances o An internal auditor analyzes account balances in a corporation's financial statements to evaluate whether such statements comply with generally accepted accounting principles (GAAP), industry practices and regulatory mandates. An auditor also tests account balances to verify "completeness" and "fairness". Complete financial reports include four statements: a balance sheet, a profit and loss statement, a cash flows statement and a statement of stockholders' equity. "Fair" means objective and accurate in accounting or audit parlance. Account Details o An internal auditor performs tests of account details to ensure that financial statements of a business entity are not "materially misstated." Tests of account details and account balances are referred to as substantive tests. An auditor conducts such tests if a firm's controls and processes are not adequate or not functioning properly. "Material" means significant or substantial in accounting and audit parlance; a misstatement could result from human errors, intentional fraud or technology system weaknesses. Internal audit This page provides an introduction to internal audit. It explains what internal auditors do and how they do it providing access to a range of guidance and other reference material. What is internal auditing? What is its value to the organisation? We all find it difficult to answer these questions.There is no simple, easily understood phrase that captures what we do. Internal auditors help our organisations to succeed - and success looks different depending on the aims of each organisation. We do this by telling the managers and governors whether the systems and processes that make sure the organisation is on track are

themselves working well. That is assurance! But, we do more than that: we also help the managers to improve those systems and processes where necessary. That is consulting! The official Definition of Internal Auditing says all that: Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organisations operations. It helps an organisation accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes. The Institute has published two short guides to raise awareness about internal audit entitled: Transparency, Reliability, Effectiveness, Ethics published by the Global Institute and What is Internal Auditing published by the IIA - UK and Ireland. Back to top Internal audit essentials We have a professional duty to provide an unbiased and objective view. We must be independent from the operations we evaluate and report to the highest level in an organisation, the senior managers and the governors, i.e. the board of directors or the board of trustees, the accounting officer or the audit committee. To be effective the internal audit activity must have qualified and skilled people who have the expereince to do things in the right way, following the Code of Ethics and the International Standards. The nature of internal auditing, its role within the organisation and the requirements for professional practice are contained within the International Professional Practices Framework (IPPF). The components and the detailed content of the IPPF are available in the Global professional guidance area of the website. This is supported by a range of practical guidance issued by the IIA UK and Ireland. Internal auditing qualifications provide the theory and practical experience so you perform effectively. You can see a full range of information in the qualification section of our website. Internal auditors also need to keep up to date with the latest knowledge and skills to ensure they are equipped to resolve new issues and advise on emerging risks. The Institute's continuous professional development (CPD) contains an online tool for assessing competencies and planning professional development. Back to top Risk based internal auditing While the responsibility for identifying and managing risks belongs to management, one of the key roles of internal audit is to provide assurance that those risks have been properly managed. Professional internal audit activity can best achieve its mission as a cornerstone of governance by positioning its work in the context of the organisations own risk management framework. This involves looking at the way managers identify, assess, respond to and report risks, as well as how well managers monitor how responses to risks are working. The Institute has published An approach to implementing Risk Based Internal Auditing that set out methodologies for assessing an organisation's risk maturity, the preparation of periodic audit plans and indvidual assurance enegagements. To learn more about risk management look at our risk management page. Back to top What internal auditors do While every internal audit is unique, the process of internal auditing is similar for most engagements and normally consists of four stages. The diagram below briefly explains what happens during each stage and the questions and actions the internal auditor needs to address for completion.

THE FOREIGN EXCHANGE MARKET

The Foreign exchange market is the market where in which currencies are bought and sold against each other. It is the largest market in the world. It is to be distinguished from a financial market where currencies are borrowed and lent. Foreign exchange market facilitate the conversion of one currency to another for various purposes like trade, payment for services, development projects, speculation etc. Since the number of participants in the market s has increased over the years have become highly competitive and efficient.

With improvement in trade between countries, there was a pressing need to have some mechanism to facilitate easy conversion of currencies. This has been made possible by the foreign exchange markets. Considering international trade, a country would prefer to import goods for which it does not have a competitive advantage, while exporting goods for which it has a competitive advantage over others. Thus trade between countries is important for common good but nations are separated by distance, which that there is a lot of time between placing an order and its actual delivery. No supplier would be willing to wait until actual delivery for receiving payments. Hence, credit is very important at every stage of the transaction. The much needed credit servicing and conversion of the currency is facilitated by the foreign exchange market. Also the exchange rates are subject to wide fluctuations. There is therefore, a constant risk associated exchange markets cover the arising out of the fluctuations in exchange rates through hedging. Forex market is not exactly a place and that there is no physical meeting but meeting is affected by mail or over phone. FOREIGN EXHANGE TRANSACTIONS Foreign exchange transactions taking place in foreign exchange markets can be broadly classified into Inter bank transactions and Merchant transactions. The foreign exchange transactions taking place among banks are known as inter bank transactions and the rates quoted are known as inter bank rates. The foreign exchange transactions that take place between a bank and its customer known as Merchant transactions and the rates quoted are known as merchant rates. Merchant transactions take place when as exporter approaches his bank to convert his sale proceeds to home currency or when an importer approaches his banker to convert domestic currency into foreign currency to pay his dues on import or when a resident approaches his bank to convert foreign currency received by him into home currency or vice versa. When a bank buys foreign exchange from a customer it sells the same in the inter bank market at a higher rate and books profit. Similarly, when a bank sells foreign exchange to a customer, it buys from the inter bank market, loads its margin and thus makes a profit in the deal. INTRODUCTION TO THE FOREIGN EXCHANGE RISK MANAGEMENT Risk: Risk is the possibility that the actual result from an action will deviate from the expected levels of result. The greater the magnitude of deviation and greater the probability of its occurrence, the greater is the risk. A business has to take step to minimize the risk by adopting appropriate technique or policies. Risk management focuses on identifying and implementing these technique or policies, lest the business should be left exposed to uncertain outcomes. Risk management: Risk management is a process to identify loss exposure faced by an organization and to select the most appropriate technique such exposures. Risk management tools measure potential loss and potential gain. It enables us to stay with varying degree of certainty and confidence levels, that our potential loss will not exceed a certain amount if we adopt a particular strategy. Risk management enables us to confront uncertainty head on, acknowledge its existence, try to measure its extent and finally control it.

Risk management makes sense for two reasons. One, a business entity generally wishes to reduce risks to acceptable levels. Two, a business entity is generally keen on avoiding particularly kind of risks, for it may be too great for the business to bear. For each situation where one wishes to avoid a risk- a loss by fire, for example- three is, perhaps, a counter party who may be willing such risk. For risk reduction, a business entity can adopt the following methods. Hedging: Hedging is a technique that enables one party to minimize the effect of adverse outcomes, in a given situation. Parties come together to minimize the effect of which risk of one party gets cancelled by the risk of another. IT is not that risk minimization is the only strategy. An entity may even choose to remain exposed, in anticipation of reaping profits from its risk taking positions. FOREIGN EXCHANGE EXPOSURE Exposure: Exposure is defined as the possibility of a change in the assets or liabilities or both of a company as a result in the exchange rate. Foreign exchange exposure thus refers to the possibility of loss or gain to a company that arises due to exchange rate fluctuations. The value of a firms assets, liabilities and operating income vary continua lly in response to changes in a myriad economic and financial variable such as exchange rates, interest rates, inflation rates, relative price and so forth. We can these uncertainties as macroeconomic environment risks. These risks affect all firms in the economy. However, the extent and nature of impact of even macroeconomic risks crucially depend upon the nature of firms business. For instance, fluctuations of exchange rate will affect net importers and exporters quite differently. The impact of interest rate fluctuations will be very different from that on a manufacturing firm. The nature of macroeconomic uncertainty can be illustrated by a number of commonly encountered situations. An appreciation of value of a foreign currency(or equivalently, a depreciation of the domestic currency), increase the domestic currency value of a firms assets and liabilities denominated in the foreign currency-foreign currency receivables and payables, banks deposits and loans, etc. It ill also change domestic currency cash flows from exports and imports. An increase in interest rates reduces the market value of a portfolio of fixed-rate in the rate of inflation may increase value of unsold stocks, the revenue from future sales as well as the future costs of production. Thus the firms exposed to uncertain changes in a numbers of variable in its environment. These variables are sometimes called Risk Factors. The nature of Exposure and Risk Exposure are a measure of the sensitivity of the value of a financial items (assets, liabilities or cash flow) to changes in the relevant risk factor while risk is a measurable of the variability of the item attributable to the risk factor. Corporate treasurers have become increasingly concerned about exchange rate and interest rate exposure and risk during the last ten to fifteen years or so. In the case of exchange rate risk, The increased awareness is firstly due to tremendous increase in the volume of cross border financial transactions (which create exposure) and secondly due to the significant increase in the degree of volatility in exchange rates(which, given the exposure, creates risk) Classification of foreign exchange exposure and risk Since the advent of floating exchange rates in 1973, firms around the world have become acutely aware of the fact that fluctuations in exchange rates expose their revenues, costs, operating cash flows and thence their market value to substantial fluctuations. Firms which have cross-border transactions-exports and imports of goods and services, foreign

borrowings and lending, foreign portfolio and direst investment etc, are directly exposed: but even purely domestic firms which have absolutely no cross border transactions are also exposed because their customers, suppliers and competition are exposed. Considerably effort has since been devoted to identifying and categorizing currency exposure and developing more and more sophisticated methods to quantify it. Foreign exchange exposure can be classified into three broad categories: Transaction exposure Translation exposure Operating exposure Of these, the first and third together are sometimes called Cash Flow Exposure while the second is referred to as Accounting Exposure or Balance sheet Exposure. Transaction exposure When a firm has a payable or receivable denominated in a foreign currency, a change in the exchange rate will alter the amount of local currency receivable or paid. Such a risk or exposure is referred to as transaction exposure. For example , if an Indian exporter has a receivable of $100,100 due three months hence and if in the meanwhile the dollar depreciates relative to the rupee a cash loss occurs. Conversely, if the dollar appreciates relative to the rupee, a cash gain occurs. In the case of payable, the outcome is of an opposite kind: a depreciation of the dollar relative to the rupee results in a gain, where as an appreciation of the dollar relative to the rupee result in a loss. Translation exposure Many multinational companies require that their accounts of foreign subsidiaries and branches get consolidated with those of it. For such consolidation, assets and liabilities expressed in foreign currencies have to be translated into domestic currencies at the exchange rate prevailing on the consolidation dates. If the values of foreign currencies change between a two or successive consolidation dates, translation exposure will arise. Operating exposure Operating exposure, like translation exposure involve an actual or potential gain or loss. While the former is specific to the transaction, the latter relates to entire investment. The essence of this operating exposure is that exchange rate changes significantly and alter the cost of firms inputs along with price of it output and thereby influence its competitive position substantially. Eg: Volkwagon had ahighly successful export market for its beetle model in the US before 1970. With the breakdown of Bretten-woods of fixes exchanged rates, the deuschemark appreciated significantly against the dollar. This created problem for Volkswagan as its expenses were mainly in deuschemark but its revenue in dollars. However, in a highly pricesensitive US market, such an action caused a sharp decreased in sales volume-from 600,000 vehicles in 1968 to 200,000 in 1976.(Incidentally, Volkswag ens 1973 losses were the highest, as of that year, suffered by any company anywhere in the world.) TOOLS AND TECHNIQUES FOR THE MANAGEMENT OF FOREIGN EXCHANGE RISK Hedging exposures, sometimes called risk management, is widely resorted to by financial directors, corporate treasurers and portfolio managers. The practice of covering exposure is designed to reduce the volatility of a firms profits and/or cash management and it presumably follows that this will reduce the volatility of the value of the firm.

There are a wide range of methods available to minimize foreign exchange risk which are classified as internal and external techniques of exposure management.

Internal techniques Internal techniques of exposure management help to resolve exposure risks through regulating the firms financial position. Thereby, they ensure that the firm is not endangered through exposures. The fundamental stress minimizing of not complete elimination of exchange losses that are likely to accrue as a result of exposure. They use methods of exposure management which are a part of a firms regulatory financial management and do not resort to special contractual relationship outside the group of companies concerned. They aim at reducing exposed position or preventing them from arising. They embrace netting, matching, leading and lagging, pricing policies and asst/liability management. Internal techniques of exposure management do not rely on 3 rd party contracts to manage exposed positions. Rather, it depends on internal financial management. External techniques These refer to the use of contractual relationship outside the group of companies so as to minimize the risk of foreign exchange losses. They insure against the possibility the exchange losses will result from an exposed position which internal measures have not been able to eliminate. They include forward contracts, borrowing short term, discounting bills receivable, factoring, government exchange risk guarantees currency options. External techniques of foreign exchange exposure management use contractual relationships outside the group to reduce risk of exchange rate changes. Several external techniques are available fore foreign exchange management. The firm can make a choice of that technique which is most suitable to it. TOOLS FOR FOREIGN EXCHANGE RISK MANAGEMNT Forward exchange contract A forward exchange contract is a mechanism by which one can ensure the value of one currency against another by fixing the rate of exchange in advance for a transaction expected to take place at a future date. Forward exchange rate is a tool to protect the exporters and importers against exchange risk under foreign exchange contract, two parties one being a banker compulsorily in India, enter into a contract to buy or sell a fixed amount of foreign currency on a specific future date or future period at a predetermined rate. The forward exchange contracts are entered into between a banker and a customer or between two bankers. Indian exporter, for instance instead of grouping in the dark or making a wild guess about what the future rate would be, enter into a contract with his banker immediately. He agrees to sell foreign exchange of specified amount and currency at a specified future date. The banker on his part agrees to buy this at a specified rate of exchange is thus assured of his price in the local currency. For example, an exporter may enter into a forward contract with the bank for 3 months deliver at Rs.49.50. This rate, as on the date of contract, is known as 3 month forward rate. When the exporter submits his bill under the contract, the banker would purchase it at the rate of Rs.49.50 irrespective of the spot rate then prevailing. When rupee was devaluated by about 18% in July 1991, many importers found their liabilities had increased overnight. The devaluation of the rupee had effect of appreciation of foreign currency in terms of rupees. The importers who had booked forward contracts to cover their imports were a happy lot.

Date of delivery According to Rule 7 of FEDAI, a forward contract is deliverable at a future date, duration of the contract being computed from the spot value date of the transaction. Thus, if a 3 months forward contract is booked on 12th February, the period of two months should commence from 14th February and contract will fall on 14th April. Fixed and option forward contracts The forward contract under which the delivery of foreign exchange should take place on a specified future date is known as Fixed Forward Contract. For instance, if on 5th March a customer enters into a three months forward contract with his bank to sell GBP 10,000, it means the customer would be presenting a bill or any other instrument on 7th June to the bank for GBP 10,000. He cannot deliver foreign exchange prior to or later than the determined date. Forward exchange is a device by which the customer tries to cover the exchange risk. The purpose will be defeated if he is unable to deliver foreign exchange exactly on the due date. In real situations, it is not possible for any exporter to determine in advance the precise date. On which he is able to complete shipment and present document to the bank. At the most, the exporter can only estimate the probably date around which he would able to complete his commitment. With a view to eliminate the difficulty in fixing the exact date of delivery of foreign exchange, the customer may be given a choice of delivery the foreign exchange during a given period of days. An arrangement whereby the customer can sell or buy from the bank foreign exchange on any day during a given period of time at a predetermined rate of exchange is known as Option Forward Contract. The rate at which the deal takes place is the option f orward sale contract with the bank with option over November. It means the customer can sell foreign exchange to the bank on any day between 1 s to 30th November is known as the Option Period. Forward contract is an effective ad easily available tool for covering exchange risk. New instruments like options, futures and swaps can also be used to cover exchange risks. These instruments are called financial derivatives as their value is derived from the value of some other financial contract or asset. When there instrument are bought or sold for covering exchange risk they are used for hedging the exchange risk. When they are dealt in with a view to derive profit from unexpected movements in their prices or other changes in the exchange market, they are being used for speculative purposes. The scope of using these instruments for speculative purposes is very much limited in India. Some other Strategies may also be adapted to avoid exchange risk. These consist in deciding on the currency of invoicing, maintaining in foreign currency and deciding on the setting the debt. Conclusion Risk is inherent in every trade you take, but as long as you can measure risk you can manage it. Just don't overlook the fact that risk can be magnified by using too much leverage in respect to your trading capital as well as being magnified by a lack of liquidity in the market. With a disciplined approach and good trading habits, taking on some risk is the only way to generate good rewards.