MANAGEMENT OF EXCHANGE RATE RISK EXPOSURE v2
MANAGEMENT OF EXCHANGE
RATE RISK EXPOSURE
There are number of ways by which exchange rate risk exposure can be managed: - Natural Hedges
- Cash Management
- Adjusting of Intracompany accounts
- International financing hedges and currency hedges through forward contracts, futures contracts, currency options and currency swaps NATURAL HEDGE
- A hedge (risk reduction action) that occurs naturally as a result of a firm’s normal operations.
For example, revenue received in a foreign currency and used to pay commitments in the same foreign currency would constitute a natural hedge.
FOUR POSSIBLE SCENARIOS ON COST AND PRICING
OF A COMPANY
CASH MANAGEMENT
If a company knew that a country’s currency where a subsidiary was based were going to fall in value, it would want to do a number of things: - reduce cash holdings in this currency to a minimum by purchasing inventories or other real assets
- subsidiary should try to avoid extended trade credit
(account receivable)
Subsidiary should try to obtain extended credit terms
Company may also want to borrow in local currency to replace any advances made by the US parent.
ADJUSTING INTRACOMPANY
ACCOUNTS
A company with multiple foreign operators can protect itself against exchange-rate risk by adjusting its commitments to transfer funds among companies.
Accelerating the timing of payments made or received in foreign currencies is called Leading and decelerating the timing is called Lagging.
Reinvoicing Center – A company-owned financial subsidiary that purchases exported goods from company affiliates and resells (reinvoices) then to other affiliates or independent customers.
INTERNATIONAL FINANCING HEDGES
If a company is exposed in one country’s currency and is hurt when the currency weakens in value, it can borrow in that country to offset the exposure.
FOREIGN COMMERCIAL BANK LOANS – one of the major sources of financing abroad to manage foreign exchange exposure
RATE RISK EXPOSURE
There are number of ways by which exchange rate risk exposure can be managed: - Natural Hedges
- Cash Management
- Adjusting of Intracompany accounts
- International financing hedges and currency hedges through forward contracts, futures contracts, currency options and currency swaps NATURAL HEDGE
- A hedge (risk reduction action) that occurs naturally as a result of a firm’s normal operations.
For example, revenue received in a foreign currency and used to pay commitments in the same foreign currency would constitute a natural hedge.
FOUR POSSIBLE SCENARIOS ON COST AND PRICING
OF A COMPANY
CASH MANAGEMENT
If a company knew that a country’s currency where a subsidiary was based were going to fall in value, it would want to do a number of things: - reduce cash holdings in this currency to a minimum by purchasing inventories or other real assets
- subsidiary should try to avoid extended trade credit
(account receivable)
Subsidiary should try to obtain extended credit terms
Company may also want to borrow in local currency to replace any advances made by the US parent.
ADJUSTING INTRACOMPANY
ACCOUNTS
A company with multiple foreign operators can protect itself against exchange-rate risk by adjusting its commitments to transfer funds among companies.
Accelerating the timing of payments made or received in foreign currencies is called Leading and decelerating the timing is called Lagging.
Reinvoicing Center – A company-owned financial subsidiary that purchases exported goods from company affiliates and resells (reinvoices) then to other affiliates or independent customers.
INTERNATIONAL FINANCING HEDGES
If a company is exposed in one country’s currency and is hurt when the currency weakens in value, it can borrow in that country to offset the exposure.
FOREIGN COMMERCIAL BANK LOANS – one of the major sources of financing abroad to manage foreign exchange exposure