Short answer
Cash flow at risk (CFaR) is the maximum amount by which a company’s expected operating cash flows can fall over a set period, at a given probability, because of market moves such as exchange rates. Unlike value at risk, CFaR does not refer to the market value of a portfolio but to planned cash flows. With several currencies, the result depends heavily on the correlation between them. In GLORIAnalytics, Correlation Adjusted measures your correlation-adjusted FX portfolio risk. For planned cash flows, it provides a scenario-based view of FX cash-flow risk; accounts and translation positions extend the picture.
What cash flow at risk measures
- Planned cash flows — receivables, payables and planned revenues in foreign currency, not the valuation of a trading book.
- A planning horizon — typically months up to the end of the budget year, matching the question “Can we hold the plan?”.
- A confidence level — for example 95%: in 95 out of 100 cases the shortfall is no larger than the CFaR.
- An amount in euros — one figure the board can compare directly with budget and risk-bearing capacity.
Cash flow at risk or value at risk?
The two measures sound alike but answer different questions. For hedging decisions based on expected operating cash flows, CFaR is usually the more direct measure.
| Value at Risk (VaR) | Cash Flow at Risk (CFaR) | |
|---|---|---|
| Question | How much market value can a portfolio lose? | By how much can planned cash flow be missed? |
| Basis | Existing positions, e.g. the hedge book | Expected operating cash flows |
| Horizon | Short, often 1 to 10 days | Planning horizon, often months |
| Typical user | Banks, trading desks, auditors of the hedge book | Corporate treasury, CFO, controlling |
Why correlation decides your CFaR
Simply adding up the risks of your currencies assumes that, when it matters, they all move in the unfavourable direction at the same time. That is the most adverse reference scenario: no offset between currencies at all. If your currencies partly offset each other, portfolio risk is lower. In the illustrative example in our white paper on correlation, this diversification effect is around 53%; in a stress phase it shrinks to around 24%.
This creates two risks pointing in opposite directions. Add up the individual risks and you often hedge more than your risk target requires. Assume too optimistic a correlation and you hedge too little – just when markets turn. A CFaR is therefore only as robust as its correlation assumption.
Correlation Adjusted: your FX cash-flow risk across the portfolio
For your planned cash flows, Correlation Adjusted answers the question a cash flow at risk also asks: by how much can your plan be missed because of exchange-rate moves, calculated across all currencies and with correlation. Accounts and translation positions extend the view to your entire FX portfolio. The difference from a static calculation lies in the ingredients.
| Static, historically calibrated calculation | Correlation Adjusted | |
|---|---|---|
| Scope | Planned cash flows | Cash flows, invoices, foreign-currency accounts and translation positions in one figure |
| Market data | Historical time series, looking backwards | Current market expectations from market-traded data, updated hourly |
| Valuation | One spot rate on the reporting date | Forward rate per maturity, risk up to each payment date |
| Direction | Symmetric range | Stronger and weaker euro shown separately |
| Correlation | Calibrated once | Recalculated daily |
| Reference | Not visible | Peak Risk with no offset always shown alongside |
- Peak Risk — the most adverse outcome within the five market scenarios considered – with no offset between currencies.
- Correlation Adjusted — the same position, calculated with the current interplay of your currencies.
- Both side by side — you decide on the basis of correlation-adjusted risk without losing sight of the no-offset reference scenario.
- Your amounts, as they stand in the system — Correlation Adjusted measures exchange-rate risk on your booked and planned amounts. Uncertainty in the planned volumes themselves is not part of the figure.
What it helps you decide
- How much to hedge: as much as your risk target requires. More on correlation-driven hedging.
- Where to hedge: in the currencies that cut total risk the most, not a little everywhere.
- What it costs: less unnecessary hedge volume lowers volume-driven transaction costs and, where relevant, option premiums. More on hedging costs.