Econ 334: International Business
Econ 334- International Business!
!
Module Leader: Mr. Prawesh Singh!
!
!
!
!
!
!
Foreign Exchange Risk and Hedging!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
Tanuj Wadhi
BABE-2014
110164
33006334
Introduction
Foreign Exchange Risk
4
5
Transaction Exposure!
5!
Translation Exposure!
6!
Economic Exposure!
7!
Hedging
Conflict Between Exposures
Conclusion
References
8
9
10
11
!
Introduction!
!
Currency has been used as a medium of exchange, for trading goods and services for around
10,000 years. It has evolved from food grains, to gold coins, to paper currency, and now plastic money, i.e., credit cards. Money only works as a medium of exchange, since people who use it, and/ or accept it have assigned a value to it. Fiat …show more content…
And since every country has their own currency, each one has its own nominal value.
Recent times have seen a surge in international trading; which in-turn has made it necessary to assign values to exchange between each currency. This phenomenon is called Foreign Exchange.
Foreign Exchange markets are set up specifically for the purpose of trading in foreign currencies, and therefore allow companies from different countries to enter into trade. This also allows companies to set up subsidiaries in other countries.
But this inter-currency trade gives rise to Foreign Exchange Risk, which basically involves the fluctuations in currency exchange rates, and its effect on forward contracts2. This risk subverts the willingness of companies to trade, and operate in foreign lands, and for this reason, a great deal of research has been done to circumvent situations of massive losses due to currency exchange fluctuations. Foreign Exchange Risk can expose the firm in broadly three different ways; Transaction
Exposure, Economic Exposure, and Translation Exposure. These financial risks will further be discussed in latter sections of this paper. …show more content…
(ii) The company imports a large amount of resources from foreign countries; either the finished product, or inputs required in the production process.
In the first case, a large fluctuation of exchange rate in the currency can cause massive deviations in expected returns and real returns, which could cause immense damage to the company, and also interrupt it’s operations, and negate the planning done by managers in view of the expected returns. In the second case, currency exchange rate fluctuations can make inputs, [and therefore], or the price of the final output more expensive, thus increasing costs for the company. Since the company is competing with others in the market, it cannot afford to increase it’s prices without affecting demand, and therefore will have to compensate on margins, and “Maintaining margins is viewed as a primary strategic goal of the firm, taking precedence over sales volume”4, signifying the importance of margins, and why they can’t be compensated.
!
Example:
(i) ABC Ltd., based in Salem, Oregon had cash inflows for the financial year 2012 of $2.3 Billion.
73% of these sales came from multiple foreign countries, including Germany, China, Japan,
!
Module Leader: Mr. Prawesh Singh!
!
!
!
!
!
!
Foreign Exchange Risk and Hedging!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
Tanuj Wadhi
BABE-2014
110164
33006334
Introduction
Foreign Exchange Risk
4
5
Transaction Exposure!
5!
Translation Exposure!
6!
Economic Exposure!
7!
Hedging
Conflict Between Exposures
Conclusion
References
8
9
10
11
!
Introduction!
!
Currency has been used as a medium of exchange, for trading goods and services for around
10,000 years. It has evolved from food grains, to gold coins, to paper currency, and now plastic money, i.e., credit cards. Money only works as a medium of exchange, since people who use it, and/ or accept it have assigned a value to it. Fiat …show more content…
And since every country has their own currency, each one has its own nominal value.
Recent times have seen a surge in international trading; which in-turn has made it necessary to assign values to exchange between each currency. This phenomenon is called Foreign Exchange.
Foreign Exchange markets are set up specifically for the purpose of trading in foreign currencies, and therefore allow companies from different countries to enter into trade. This also allows companies to set up subsidiaries in other countries.
But this inter-currency trade gives rise to Foreign Exchange Risk, which basically involves the fluctuations in currency exchange rates, and its effect on forward contracts2. This risk subverts the willingness of companies to trade, and operate in foreign lands, and for this reason, a great deal of research has been done to circumvent situations of massive losses due to currency exchange fluctuations. Foreign Exchange Risk can expose the firm in broadly three different ways; Transaction
Exposure, Economic Exposure, and Translation Exposure. These financial risks will further be discussed in latter sections of this paper. …show more content…
(ii) The company imports a large amount of resources from foreign countries; either the finished product, or inputs required in the production process.
In the first case, a large fluctuation of exchange rate in the currency can cause massive deviations in expected returns and real returns, which could cause immense damage to the company, and also interrupt it’s operations, and negate the planning done by managers in view of the expected returns. In the second case, currency exchange rate fluctuations can make inputs, [and therefore], or the price of the final output more expensive, thus increasing costs for the company. Since the company is competing with others in the market, it cannot afford to increase it’s prices without affecting demand, and therefore will have to compensate on margins, and “Maintaining margins is viewed as a primary strategic goal of the firm, taking precedence over sales volume”4, signifying the importance of margins, and why they can’t be compensated.
!
Example:
(i) ABC Ltd., based in Salem, Oregon had cash inflows for the financial year 2012 of $2.3 Billion.
73% of these sales came from multiple foreign countries, including Germany, China, Japan,