Foreign Currency Management Pdf

Foreign Currency Management replace score This is the value at which the up-to-dateness of one coarse would change hands with currency of some other country. E. g. $1 = SLR cxxx Types of Exchange Rate 1. spoiling Rate This measure depends on a levels of the world-wide trade of a country and it does not interfere with the organisation of that country. 2. Fixed Rate This is the rate that the political sympathies of the country would set its own currency rate and it is not depending on the market rate. 3. Dirty Float This is the rate that mixed betwixt floating rate and fixed rate system.This is where the government would allow rallying rate to float between a particular cardinal limits. If it goes outside either of the limit, thus the government would take further action. Forex Dealings 1. Bid equipment casualty The price at which the currency is bought by the dealer. 2. hold out Price The price at which the currency is sold by the dealer. When regarding the forex dea lings, Offer Price Bid Price vitrine 01 David is a UK businessman. He needs $ 400,000 to buy US equipment. Identify the amount of ? equired to buy the Dollars? ($/? 1. 75 1. 77) Answer The amount of ? required = $ 400,000 $/? 1. 75 = ? 228571. 43 Example 02 James is a US businessman. He has just reliable a payment of ? 150,000 from his main customer in UK. Identify the amount of $ accredited by James when ? 150,000 are devoted? (? /$ 0. 61 0. 63) Answer The amount of $ received = ? 150,000 ? /$ 0. 63 = $ 238095. 24 Spot Rate and Forward Rate Spot Rate This is the rate which is applicable for the immediate oral communication of currency as at now.Forward Rate This is a rate that set for the future transaction for a fixed amount of currency. The transaction would take place on the future picture at this hold rate by disregarding the market rate. Discounts & Premiums Discounts If the preliminary rate which is quoted cheaper, then it is set to be quoted at a discount. E. g. $ /? current percentage point is 1. 8500-1. 8800 and the one month forward rate at 0. 0008-0. 0012 at a discount. When quoted at a discount, Answer 1. 8500-1. 8800 their should be more Dollars + 0. 0008-0. 0012 being received at a given Pound. = 1. 508-1. 8812 So the discount factor adjudge to be added to the spot rate. Premiums If the forward rate which is quoted more expensively, then it is set to be quoted at a premium. E. g. $/? current spot is 1. 9000-1. 9300 and the one month forward rate at 0. 0010-0. 0007 at a premium. When quoted at a premium, Answer their should be less Dollars being 1. 9000-1. 9300 received at a given Pound because 0. 0010-0. 0007 of the expensiveness of Dollars. So = 1. 8990-1. 9293 the premium factor have to be deducted from the spot rate. Foreign Exchange Rate Risks . Transaction Risk This is the danger that adverse central rate causal agent occurring in the cause of normal international trading transaction. This arises when the prices of imports or exports are fixed in remote currency terms and there is a movement in the convince rate between the date when the price is agreed and when the cash is paid or received. 2. Translation Risk This is the risk that the organization provide made rally losses when the accounting results of its contrary branches or subsidiaries translated into the local currency. . Economic Risk This is the risk that suppose to a effect of exchange rate movements on the international competitiveness of the company. 4. Direct & validating Currency Quotes Direct Quote This means the exchange rate is mentioned in terms of the amount of home(prenominal) currency which needs to be given in returns for one unit of abroad currency. E. g. SLR 130 for $1 In channelise Quote This means the amount of foreign currency units that needs to be given to notice one unit of domestic currency. E. g. $ 1/130 for SLR 1 Example 01ABC Ltd is a US company, acquire goods from Sri Lanka which cost SLR 200,000. These good s are resold in the US for $2000 at the metre of the import purchased. The current spot rate is $1 = SLR 126-130. Calculate the expected profit of the resale in terms of US Dollars using both direct & indirect quote methods. Answer 1. ) Under Direct Quote Method $/SLR = 1/126 1/130 = 0. 00794 0. 00769 Sales = $2000 (-)Purchase cost=SLR200,000*$/SLR0. 00794 =($1588) Expected Profit = $412 2. ) Under Indirect Quote Method Sales (-)Purchase Cost=SLR200,000/SLR126/$ Expected Profit = $2000 =($1587) = $413Managing the Exchange Rate Risk 1. Invoicing in domestic currency Since the exporter does not have to do any currency transaction in this method, the risk of currency conversion is transferred to the importer or frailness versa. 2. bullion Market Hedging Because of the close relationship between forward exchange rate and the cheer rate in two currencies, it is possible to calculate a forward rate by using the spot exchange rate and money market lending or borrowing which is call ed as a money market hedge.Feature article aboutProduction Management3.Entering into Forward Exchange Rate Contracts A person can enter into an agreement with a bank to purchase the foreign currency on the fixed date at a fixed rate. 4. Matching receipts & payments Under this method a company can set off its payments against its receipts in that particular currency. 5. Options These are similar to forward trade agreements, but the consumer can choose between the banks rate and the market rate. Example 01 A Sri Lankan company has to settle $800,000 after three months time. The current spot rate is $1 = SLR 126-130.The foreign currency depositing interest rate is 12%per annum and the borrowing rate in Sri Lanka is 8% per annum. The agreed exchange rate with the bank is $1 = SLR128. The company has identified to overcome the exchange rate under Money Market Hedging & Forward Exchange Rate Contract methods. Identify the cheapest method to overcome the exchange rate risk. Answer 1. ) Usi ng Money Market Hedging Method FV = PV* (1+r)n PV = $800,000* (1+ 0. 03)-1 PV = $776,699 r = 0. 12*3/12 r = 0. 03 n=1 Purchase Cost(SLR) = $776,699*SLR130/$1 = SLR 100,970,870 Interest Cost(SLR) = SLR 100,970,870*0. 8*3/12 = SLR 2,019,417 Total Cost(SLR) = SLR(100,970,870+2,019,417) = SLR 102,990,287 2. ) Using Forward Exchange Rate Contract Method Total Cost (SLR) = $ 800,000*SLR128/$1 = $102,400,000 The best method is forward Exchange Rate Contract Method, because it gives the lowest total cost when correspond to Money Market Hedging Method. Reasons for Short Term Changes of Exchange Rate 1. Investment Flows If a country does more investment to outside countries, then there would be a higher(prenominal) demand for foreign currency. Therefore the domestic will depreciated or vice versa. 2.Trade Flows In a given time if a country has more imports and less exports, the domestic currency will depreciated, because of the higher demand for the foreign currency or vice versa. 3. Economi c Prospectus If a country has good stinting policies and is showing shines of economic growth, it could receive more investment and therefore the domestic currency would appreciated. Reasons for Long Term Changes of Exchange Rate 1. Purchasing Power para Theory This theory describes how the differences in inflation rate among two countries would breath to changes in the exchange rates.Future Rate(A/B)=Spot Rate(A/B) * (1+ Inflation Rate of A) (1 +Inflation Rate of B) 2. Interest Rate Parity Theory This theory links the future currency rates with differences in interest rate among two countries. Future Rate(A/B)=Spot Rate(A/B) * (1+ Interest Rate of A) (1 +Interest Rate of B) 3. Monetarist Theory This theory identifies the relationship between exchange rate and the government money supply to an economy of one country. E. g. When the government released more money to their economy, individual would have more money.So they would purchased more, the demand will increased & through tha t result in higher prices & high inflation. This would lead to a high level of depreciation to the currency. 4. Keynesian Approach This theory says that an exchange rate whitethorn not change in a balance and sometimes currency may continuously appreciate or depreciate without reverse. E. g. There is a high taste & demand for merchandise product in one country while their exports are losing its export position in other countries. Therefore, without any appreciation of currency will continuously depreciate over a long time period in that country.