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Foreign exchange market introduction
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What is hedging? Hedging is a strategy used to protect risks posed by worldwide currency fluctuations. One hedges the currency risk by contracting to sell foreign currency in the future, at the current exchange rate (Fries). If fund managers think the dollar is going to be stronger when they are ready to change the foreign currency back into American dollars, then they take out a foreign futures contract (a hedge). Thus, they lock in the exchange rate beforehand, so that they will not lose profits gained from holding devalued foreign currency (Hedging, 1999). If the manager guesses correctly, he will boost the fund’s overall return because the profits will be worth even more when they are exchanged into American dollars. The foreign exchange market is one of the most important financial markets. It influences the relative price of goods between countries and can shape trade. It influences the price of imports and can have an effect on a country’s price level (inflation rate). In addition, it influences the international investment and financing decisions. Exchange rates present many risks to a company and a company must be able to hedge itself (Gray, 2003). The price of one currency expressed in terms of another currency is called an exchange rate (Gray, 2003). Foreign investors need to sell in a foreign currency to be competitive. By making the most of the exchange rate risk, it may take away some of the risk of the cross border trade from customers. This in turn may encourage a customer to buy products. Exchange rates are the amount of one country’s currency needed to purchase one unit of another currency (Gray, 2003). Typically, vacationers wanting to exchange money will not be bothered with shifts in the exchange rates. However, for multinational companies, dealing with very large amounts of money in their transactions, the rise or fall of a currency can mean receiving a surplus or a deficit on their balance sheets, which is an example of translation risk. Translation risk is more of an accounting issue, and refers primarily to the impact of exchange rates on earnings and balance sheet items (Hedging, 1999). Another type of exchange risk faced by multinational companies is transaction risk. If a company sells products to an overseas customer, it might be subject to transaction risk. Transaction risk refers to actual conversions of cash flows from one c... ... middle of paper ... ...to the American dollar will affect the total loss or gain on the investment when the money is converted back. This risk usually affects businesses, but it can also affect individual investors who make international investments, also called currency risk (Investorworld). References http://www.investorwords.com/1808/exchange_rate_risk.html retrieved February 27, 2005 Fries, Bill. Thornburg Articles. Currency Hedging retrieved February 24, 2005 from http://www.thornburginvestments.com/research/articles/Currency%20Hedging.asp Gray, Phil and Irwin, Tim. (2003). Allocating Exchange Rate Risk in Private Infrastructure Contracts retrieved February 24, 2005 from http://rru.worldbank.org/Discussions/Topics/Topic21.aspx Hedging Currency Risk with Options and Futures retrieved February 25, 2005 from http://www.goldencapital.com/research/reports/hedging.htm Kaepplinger, Peter (1990). The CPA Journal Online Foreign currency hedging transactions under Section 988Temporary regulations Retrieved February 24, 2005 from http://www.nysscpa.org/cpajournal/old/08660556.htm
Saputo’s business is constantly affected by changes in the exchange rate as the majority of its business takes place outside of Canada. Due to the fact products and cash flows travel internationally, the company is exposed to economic exposures. Exchange exposure affects Saputo in many ways such as the cost of production and demand for their products. Transaction exposure affects Saputo when cash flows from foreign operations into Canada. Saputo is affected by translation exposure when foreign revenue is converted into Canadian dollars for its financial statements.
So when the dollar is depreciating, the exchange rate becomes smaller. Exchange rate (foreign exchange rate, forex rate or FX rate) is the number of units of a given currency that can be purchased for one unit of another currency. The United States capital markets are becoming more attractive to foreign investors. Since the dollar is falling, it makes foreigner’s investment in the United States more affordable. Therefore, foreigners take this opportunity to invest in the United States.
I also invested in currencies like the US dollar, the Canadian dollar and the New Zealand dollar. I found that the US dollar dropped by a considerable amount whilst the Canadian dollar and the New Zealand dollar had a minimal increase in
• Jaguar Treasury should engage in Forward/Swap Contracts to Sell US$ and hedge against currency fluctuations.
In addition, the future exchange rate can lead to decrease Tiffany 's profits because the yen is thought to be overvalued in comparison to the dollar. These risks are fairly serious because the extreme volatility in the exchange rate creates significant uncertainty in what the future exchange rate and profits will be.
International investing is something that many investors find that they can benefit from for many reasons. Two of the main reasons why investors choose to invest in foreign markets are growth and diversification. Growth allows investors the potential to take advantage of new opportunities in foreign emerging markets. International markets can potentially offer opportunities that might not be available in the United States. Diversification allows investors to spread out their risk to different markets and foreign companies other than those just in the United States allowing them to potentially create larger returns on their investment as well as reducing risks. (U.S. Securities and Exchange Commission, 2012) While investing internationally can be a very lucrative and rewarding decision, there are also extra risks involved with investing internationally. One of the main risks that international investors encounter is foreign exchange risk also known as currency risk. Currency risk is a financial risk that is created by contact with unforeseen changes in the exchange rate between two currencies. These changes can cause unpredictable gains or losses when profits from investments are converted from a foreign currency to the United Stated dollar. There are precautions that can be taken by investors to potentially lower their risk of currency value fluctuations and other risk factors that are present in international investing. (Gibley, 2012)
The value of the US dollar relevant to other currencies is a major consideration for the Federal Reserve. If they prevent large changes in the value of the dollar, firms and individuals can comfortably plan ahead to purchase or sell goods abroad.
The expanding global market has created both staggering wealth for some and the promise of it for others. Business is more competitive than ever before, and every business, financial or product-based, regardless of size or international presence is obligated to operate as efficiently as possible. A major factor in that efficient operation is to take advantage of every opportunity to maximize profits. Many multinational organizations have used derivatives for years in financial risk management activities. These same actions that can protect multinational organizations against interest rate futures and currency fluctuations can be used to create profits for those same organizations.
Hedging risk has two sides, such as advantage and disadvantage. The main benefit of hedging is to help reduce risk of financial distress that firm might face, and it helps firm to insure themselves from negative event which could lead to financial distress, such as: Inflation, currency rate volatility and interest rates changes. Moreover, it could protect company from distress to the extent where reducing distress cost exceeds the cost of hedging which will increases the value of the firm.
Other types of exchange rate risks are translation risk and so-called hidden risk. The translation risk relates to cases where large multinational companies have subsidiaries in other countries. On the financial statement of the whole group, the company may have to translate the assets and liabilities from foreign accounts into the group statement. The translation will involve foreign exchange exposure. The term hidden risk evolves around the fact that all companies are subject to exchange rate risks, even if they don’t do business with companies using other currencies. A company that is buying supplies from a local manufacturer might be affected of fluctuating foreign exchange rates if the local manufacturer is doing business with overseas companies. If a manufacturer goes out of business, or experience heavy losses, it will affect all the companies it does business with. The co...
After the financial crisis of the late 1990s, the demands for risk management tools have increased. The investors have been effectively utilizing such products as KOSPI 200 futures and options, 3-Year KTB futures and USD futures to meet their hedging needs.
The stability of currency values plays a significant role for economic and financial stability. It is not difficult to see the exchange rate fluctuations are widely regarded as damaging. As the movements of the exchange rate have significant and large effects on the trade balance, resource allocation, domestic prices, interest rate, national income and other key economic variables. Then can exchange rate movements be predicted by these fundamental economic variables?
There are three main political risks that can be encountered when moving business overseas which are: confiscation, expropriation, and domestication. Each of these risks can have significant adverse effects on a company that is trying to expand into foreign countries. Of the three, confiscation is considered to be the most severe political
This is a real risk and one must be congnizant of the effect of a revaluation or devaluation of the currency either in the home country or in the country the company deals in devaluation in the home country would make the company’s product more attractive in other country. its would also make imports more expensive and if a company is dependent on import margins can get reduced. On the other hand devaluation in the country to which one export would make the company’s products more expensive and this can adversely impact sales.
The foreign exchange market is one of important mechanism in the international business because foreign exchange is an intermediary for all nations in term of the growth of the economy. There are many functions of foreign exchange market in the global economy. In the international business, it uses the foreign exchange markets in four ways. First, the pay...