11/11/2014

Consideration for Foreign Exchange:

Convertibility- how easy a currency can be exchanged into another
one. USD always convertible, Yen always convertible, some European nations
are not. How desirable is another countrys currency, how desirable are the
profits
Exchange Restrictions- blocked currency (cant take currency out of
the country, cant take profits out-way to restrict exports to bring capital and
skills to country) multiple exchange rate (favorable-industries they want,
Unfavorable-they dont want).
Need for Hedging- need to protect your expected profits

Things that effect future foreign exchange rates:

Balance of Payments- (affected by exchange rates, affected by
stronger dollar and effects foreign exchange rates High interest payments
put downward pressure on our foreign exchange-picks up exports brings in
money)
Relative Interest Rate- the interest rate of country A < country B,
we expect As currency to strengthen (relative to other) in the future.
Interest parity. Short term investment would use B, long term would use A.
Relative Inflation Rates- if inflation rate of A> B, we expect Bs
currency to strengthen. (purchasing power of parity). Inflation will erode
spending power.
Expectation/Recent Fluctuations- make decisions based on closing
prices and sales (stocks)
Politics- stability in politics makes debt loans more attractive for other
countries.
Monetary Policy- (big part of BOP) money supplied, big indicator of
inflation, involved in politics.
Risks of Foreign Exchange:
Translation Risk- exposure that comes from translating financial
statements from overseas to your home country/reporting countries. The
money you invest or youre supposed to get back may change. Risk of losing
value of your assets. Accounting statement risk
Transaction Risk-cash flow risk, accounts payable, accounts
receivable risk. Paying something at seas is at risk, change is the risk.
Economic Risk-deals with long term health of firm. Being locked into
equipment, contracts, foreign, and other things long-term that you cant
liquidate. Stuck with
Hedging against Risk
Cant eliminate risk, but how do you protect it?

Forward Market- locking into what you are going to pay or receive.
Not trying to make money trying to make what you expect.
Forward Market + Options- have option not to exercise forward
market, depending on market rate. This costs more because you have to pay
for it. Youre betting more and hedging incase market goes in favor, it is also
limiting downside potential, it is a high cost though.
Use Local Money Markets- global companies have many markets to
choose from to determine what currency to use. Choose currency with that
is worth the most at the time.
Use home country currency as much as possible?