Abstract

Showing and Valuating Forward Exchange and Interest Rate Futures Deals on Bank Balance Sheets — Part I

Forward exchange and interest rate futures deals have at least two essential common characteristics: First, under the present financial presentation practices there is no chance of identifying them in credit institutions’ annual financial statements. Second, both may either increase or reduce risks depending on the degree of hedging. At present, external earnings analyses are not or, at best, only partially capable of making this distinction of crucial economic importance and are ultimately distorted precisely for this deficiency. There is the danger that, as a reporting medium, the annual financial statement will sooner or later not be in a position any more to meet part of the functions assigned to it by the commercial law, if these types of deal, the significance of which is on the increase both in qualitative and in quantitative terms, fails almost completely to appear on annual financial statements and if the losses threatening to arise in connexion with such deals continue to be valuated in accordance with the single-asset valuation and the prudence principles — a method that is basically correct, but inappropriate in this context.

This first of three parts of the study begins by sketching out the technical operations involved in selected forward exchange and interest rate futures deals (one variant of each in treading both on and off the floor. Section II), before it is possible to discuss the most important profit determinants (exchange and interest rate fluctuation, fulfilment risk) and to outline the interrelations of such determinants both with corresponding asset accounts and among themselves (Section III).

This yardstick to measure the material risk structures is the one to be used when assessing the relevant accounting and financial presentation practices customarily applied at present (Section IV).

The results obtained in this part of the study form the basis of alternative concepts to be explained in subsequent publications. In order to facilitate access to these extremely complex problems, part II will be confined to a discussion of balance-sheet aspects and risk-bearing elements in exchange and interest rates exclusively; this discussion will be extended to include in part III special aspects of forward exchange and interest rate futures deals stemming from the state of suspension of such deals.