Position Keeping

Net Cash Flow Position

There is said to be a 'position' if circumstances are such that a change in a rate will create a profit or loss. If cash inflows and cash outflows are unequal or have mismatched value dates, there is a 'net cash flow position'. Seperate net cash flow positions apply for each value date.

Net cash flow position = cash inflow - cash outflow

A positive net cash flow position reflects an excess of cash inflow, over cash outflow, on the relevant value date. The surplus cash will be available for investment. If interest rates rise the return will be higher. If interest rates fall, the return will be lower.

A negative net cash flow position reflects an excess of cash outflow overcash inflow on the relevant value date. Assuming there are no idle balances, the account will become overdrawn. The shortfall of cash will require funding. If interest rates rise it will become more expensive to fund the account. If interest rates fall it will become less expensive to fund the account.

A negative net cash flow position also implies a 'liquidity position'. There is a risk that there will be insufficient funds available for borrowing, in which case the account must remain overdrawn. Being overdrawn may involve financial and non-financial penalties.

If cash inflow equals cash outflow on a particular value date, then the net cash flow position is zero. This is referred to as a 'square cash flow position'. Changes in interest rates will have no net impact on profits or losses.

Net Exchange Position

Buying and selling foreign currencies creates exposure to changes in exchange rates. Buying a foreign currency creates an asset. The position is said to be 'long' the foreign currency. If the foreign currency appreciates there will be an exchange gain. If the currency depreciates there will be an exchange loss.

Selling a foreign currency creates a liability. The position is said to be 'short' the foreign currency. If the foreign currency depreciates there will be an exchange gain. If the foreign currency appreciates there will be an exchange loss.

The excess amount of a foreign currency which has been purchased over the amount of the same foreign currency which has been sold is described as the 'net exchange position'. There is a seperate net exchange position for each foreign currency.

Net exchange position = foreign currency purchased - foreign currency sold

Being long a currency implies having a net exchange position which is positive. Provided the exchange rate is quoted with the foreign currency as the base currency, a rise in the exchange rate will yield an exchange gain and a fall in the exchange rate will result in an exchange loss.

Being short a currency implies having a net exchange position which is negative. Provided the foreign currency is the base currency, a rise in the exchange rate will result in an exchange loss, and a fall in the exchange rate will cause an exchange gain.

If the amount of foreign currency purchased equals the amount of that currency that has been sold, then the net exchange position will be zero. This is referred to as a 'square exchange position'. Changes in exchange rates will have no impact on profit or loss.

A net exchange position is created or removed at the time the purchase or sale of foreign currency is contracted, not at the time when the related cash flows occur. For example, if a spot contract is entered into today to purchase USD 1 million against JPY at a rate of USD 1 = 120.50, the buyer immediately becomes long USD and short JPY regardless of the fact that he or she will not receive the USD or pay away the JPY until two business days hence. Similarly, forward purchases or sales of foreign currency immediately create, or remove a net exchange position.

Distinction between Net Exchange Position and Net Cash Flow Position

It is important to appreciate the disctinction between a net exchangte position, and a net cash flow position. Money market transactions create net cash flow positions, but do not create net exchange positions. Only buying buying or selling a currency can create a net exchange position - merely borrowing or lending a foreign currency does not.

Borrowing CHF for three months will cause a positive cash flow of swiss francs now and a negative cash flow of CHF in three months time, but no exposure to the exchange rate. Unless the CHF are sold (which create a net exchange position), they will be available to repay the loan on maturity and so exchange rate changes will have no effect on profit or loss.

Foreign exchange transactions create both net cash flows positions and net exchange positions. Mismatched cash flows may be offset by either money market transactions or foreign exchange transactions. However, net exchange positions can only be offset by foreign exchange transactions.