31. To illustrate the potential impact of the payments system infrastructure and market practices on the size of a bank's FX settlement exposure, it is useful to consider the following hypothetical spot trades between a bank and a single counterparty involving Japanese yen (JPY), Deutsche Mark (DEM) and US dollars (USD):

Hypothetical portfolio

Currency sold	Currency bought	Amount bought (in USD millions)
USD	JPY	15
DEM	JPY	10
USD	DEM	20
JPY	DEM	15
DEM	USD	20
JPY	USD	20
		100

32. Let it be assumed that these same trades were conducted every day for four consecutive business days - Tuesday, Wednesday, Thursday and Friday - and that exchange rates were stable over the period. Since these are spot transactions, Tuesday's trades will settle on the following Thursday; Wednesday's trades will settle on Friday; Thursday's trades will settle on Monday; and Friday's trades will settle on Tuesday.

33. What would be the status of each of these trades on Friday at 11 a.m. New York time, on the assumption that Friday's trading has been completed by that time? Table 1a answers this question from the perspective of a hypothetical "worst-case" North American bank as defined by the market survey.

34. Tuesday's trades. All of Tuesday's trades - the trades that should have settled on Thursday - have Status U. This reflects the finding that a "worst-case" North American bank does not identify its final and failed receipts until the afternoon on the day following settlement. Thus Thursday's receipts of Tuesday's purchases will not be verified until Friday afternoon.

35. Wednesday's trades. Payment instructions for the currencies sold on Wednesday for value Friday became irrevocable either on Wednesday (for JPY and DEM) or on Thursday (for USD). Those trades that involved the purchase of JPY or DEM have Status U since those currencies should already have been received by 11 a.m. New York time; those trades that involved the purchase of USD have Status I since the USD receipts are not due until later in the day.

36. Thursday's trades. Payment instructions for Thursday's sales of JPY and DEM for settlement on Monday became irrevocable late on Thursday, and so are classified as Status I. Payment instructions for Thursday's sales of USD, however, can be cancelled unilaterally until late on Friday and so are still classified as Status R.

37. Friday's trades. The bank has not yet issued any irrevocable payment instructions for Friday's currency sales, and so all of these trades have Status R.

38. Fails. For the sake of simplicity, the bank is assumed to have no outstanding identified fails with this counterparty as of 11 a.m. on Friday (i.e. no trades have Status F at that time).

39. On the basis of the status of these transactions, Table 1a calculates the FX settlement exposure of the hypothetical US$ 100 million in daily trades from the perspective of a "worst-case" North American bank as of Friday, 11 a.m. (Tables 1b and 1c provide similar calculations from the perspective of a "worst-case" Asian and European bank at the same moment in time.) The bank's minimum exposure at that time would equal US$ 105 million, consisting of irrevocable purchases of USD due later on Friday (value US$ 40 million) plus irrevocable instructions to pay JPY and DEM on Monday (value US$ 65 million).

40. The bank's maximum exposure would equal US$ 265 million, or more than two and a half times its daily trading. Its maximum exposure would consist of its minimum exposure (value US$ 105 million) plus the amount of funds that should - but might not - have been received on Thursday (all purchases, value US$ 100 million) and Friday (JPY and DEM purchases, value US$ 60 million).

41. Figure 1a projects - as of Friday, 11 a.m. New York time - a "worst-case" North American bank's potential minimum exposure in settling the hypothetical US$ 100 million daily portfolio. At a minimum, its current US$ 105 million exposure will peak at least temporarily at US$ 205 million, or more than double its daily trading. This peak will be reached during Friday afternoon as the bank's USD payment instructions for Monday (value US$ 35 million) and its JPY and DEM payment instructions for Tuesday (value US$ 65 million) become irrevocable. Its minimum exposure will then fall to US$ 165 million as it receives the USD due later on Friday.

42. Minimum exposure will remain at US$ 165 million throughout most of the weekend. Early on Monday morning the minimum exposure is expected to fall as the bank receives the currencies it has irrevocably purchased for delivery on Monday and Tuesday. The only other high in its minimum exposure is projected to occur on Monday afternoon, the time at which its USD payment instructions for Tuesday become irrevocable.

43. Figure 1a also shows the two extreme scenarios for the bank's projected maximum exposure. The first scenario, labelled Maximum exposure if identified fails = 0%, equals the bank's projected minimum exposure plus its projected Status U trades. This is the bank's forecast of the maximum amount for which it will consider itself at risk at each point in the future on the assumption that it will not identify any new failed receipts over the projection interval. As indicated in the chart, this amount will rise with the issuance of irrevocable payment instructions and fall with the projected successful verification of final receipts.

44. For instance, from Friday evening until late on Monday morning the bank's Maximum exposure if identified fails = 0% is projected to equal US$ 265 million: during this time the bank will not know whether it received the amounts due on Friday (value US$ 100 million); it will be awaiting either the receipt or verification of the receipt of irrevocably purchased funds due on Monday (value US$ 100 million); and it will have issued JPY and DEM payment instructions for Tuesday (value US$ 65 million) which can no longer be cancelled unilaterally. Furthermore, since the bank in this example does not identify its final and failed receipts until late on the day following settlement, the earliest time at which it will be in a position to assure itself that it no longer has any potential FX settlement exposure from these hypothetical trades will be late on Wednesday (i.e. after it verifies Tuesday's receipts).

45. Figure 1a also shows the second extreme scenario for the bank's projected maximum exposure in settling the hypothetical portfolio. This projected path, labelled Maximum exposure if identified fails = 100%, could potentially rise to US$ 400 million. This level would be reached if (i) the bank learns that it did not, in fact, receive payment on any trade with Status U as of Friday, 11 a.m. (value US$ 160 million); (ii) the bank does not receive payment on any trade with Status I at that time (value US$ 105 million); and (iii) despite these fails the bank follows its routine scheduling procedures and issues irrevocable payment instructions for trades that currently have Status R (value US$ 135 million). In essence, this scenario shows how quickly all of the currently US$ 400 million in unsettled trades - including those that still have Status R - could potentially build up into actual exposures. Figures 1b and 1c show similar projections for a "worst-case" Asian and European bank.