Exports and Imports (rise in currency)
A rise in the value of a nation’s currency makes its exports less competitive and imports cheaper
Exports and Imports (fall in currency)
A fall in the value of a nation’s currency makes imports more expensive and increases the competitiveness of exports
Exports and Imports (exports more than imports)
The demand for its currency will tend to increase. Currency strengthens
Exports and Imports (imports more than exports)
Currency weakens as supply > demand. Trade surplus
When does translation loss arise?
If the domestic currencyappreciatesagainst the foreign currency
When does translation gain arise?
If the domestic currencydepreciatesagainst the foreign currency
What is economic risk?
Risk that cash flows will be affected by long-term exchange rate movements
What is transaction risk?
It is the risk that theexchange ratechanges between the contracting date of a specific export/import and the related receipt/payment of foreign currency
Short-term version of economic risk
How can transaction risk be effectively managed?
Canbe effectively managed using internal and external hedging techniques.
Exchange Rate Techniques (Leading)
Converting domestic currency into foreign currency earlier than needed to pay suppliers(leading), currency is expected to fall
Exchange Rate Techniques (Lagging)
delaying conversion and paying suppliers late (“lagging”), if the domestic currency is expected to appreciate
Exchange Rate Techniques (Netting)
Both sales/receivables and purchases/payables in a foreign currency, so the net exposure is only on the difference between receivables and payables
Result in a reduction in foreign exchange purchase costs and money transmission costs
Exchange Rate Techniques
Overseas subsidiaries borrow locally rather than receive finance from the parent. This reduces the net assets of the subsidiary
Reduces exposure to translation risk on consolidation of the subsidiaries’ net assets in the group accounts
Exchange Rate Techniques (Forward Exchange Contracts)
A forward contract is a legally binding agreement to buy or sell: A specified quantity, an agreed future date
Forward contracts are not traded but agreements between a company and a counterparty
There is nopremiumto be paid to set up a forward hedge (unlike options)
The major disadvantage of forward contracts is thatphysical deliverymust occur
Exchange Rate Techniques (Currency Options)
A company may consider buying a currency option if it wants a more flexiblehedge
The purchaser of a currency option has the right, but not the obligation, to buy or sell: A specified quantity, on or before a specified date
Premiums are paid at the date the option is bought and are non-refundable
Exchange Rate Techniques (Currency Options) (Call)
Acalloption gives its owner the right tobuythe underlying asset
Exchange Rate Techniques (Currency Options) (Put)
Aputoption gives its owner the right tosellthe underlying asset
Exchange Rate Techniques (Futures Contract)
Buyer has a binding obligation to buy a fixed amount (the contract size) at a fixed price (the futures price) on a specified date (the delivery date) of some underlying asset via a recognised exchange
Currency futures contracts arestandardisedcontracts for the buying or selling of a specified quantity of a currency
Futures areexchange-tradedforward contracts
A company can choose: whether to buy or sell futures and which delivery date to use
However, most currency futures contracts are “closed out”beforedelivery. The company executes the opposite transaction to the initial futures position
Unlike forward contracts where is always a physical delivery
Exchange Rate Techniques (Currency Swap)
An agreement in which two parties exchange the principal amount of a loan and the interest in one currency for the principal and interest in another currency
On commencement of the swap – an exchange of agreed principal amounts, usually at the prevailing spot rate
Over the life of the swap – an exchange of interest payments
At the end of the swap – a re-exchange of principals, usually at theoriginalspot rate
Not suitable for hedging a one-off transaction
Exposure to Rising Interest Rates Situations (floating debt)
If it has a significant proportion of floating (i.e. variable) interest rate debt, as this leads to lower profits
Exposure to Rising Interest Rates Situations (surplus)
If a significant amount of surplus cash has been invested infixedinterest rate securities
Exposure to Falling Interest Rates Situations (fixed interest)
If it has a significant proportion offixedinterest rate debt and cannot benefit from falling rates
Exposure to Falling Interest Rates Situations (floating investment)
If it holds significantfloatingrate investments (e.g. money market investments)
Gap Exposure (What is it)
Gap exposure is the difference between theamountsof interest-sensitive assets and liabilities
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A Rote123
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A Theory41
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B Rote129
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B Theory128
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C Rote217
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C Theory171
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C Formulas42
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C Section C Theory100
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B&A Spreadsheet39
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C Spreadsheet43
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D Rote185
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D Theory143
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D Section C Theory125
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D Spreadsheet61
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D Formulas65
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E Rote245
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E Section C Theory116
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E Theory240
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E Formulas119
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E Spreadsheet133
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F Rote179
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F Theory56
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F Formulas56
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G Rote275
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G Theory99
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G Formulas38
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G Spreadsheet57
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Ratios38
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F Ratios31
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Islamic5
