BSB119 Lecture Notes - Lecture 10: Foreign Exchange Market, The Foreign Exchange, Japanese Yen
Week 10 Global Business Lecture Notes
Foreign Exchange and Risk Management
1. Implications of Exchange Rate Movement on International Firms
• Exchange rate implications arise when the following strategic questions are
considered by international firms:
o Where to export to (or import from)?
o Where to get the best return on foreign investment?
o Where to locate production? Where to source supplies?
o In which currency should the firm borrow?
o In which currency should the firm quote prices?
o Forecast earnings of subsidiaries in home currency?
o How to manage against currency volatility and risk?
• Future cash flow projections, profitability, competitiveness and the ability to service
debt can all be impacted by foreign exchange volatility when paying or receiving
foreign currency
• All businesses trading overseas (and increasingly, even in domestic markets), will be
exposed to exchange rate movements either directly or indirectly
• Consider:
o Foreign payables:- eg. when businesses need to pay foreign sellers for goods
or services purchased, repay loan in foreign currency, etc.
o Foreign receivables:- eg. when businesses receive payment from foreign
buyers for goods sold or services rendered, repatriate profits from foreign
markets, etc.
2. The Foreign Exchange Market
• The foreign exchange market is
o A market for converting the currency of one country into that of another
country
o A global network of banks, brokers and foreign exchange dealers connected
by electronic communications systems
o Major trading centres
▪ London (41%), New York (19%), Singapore (5.7%), Tokyo (5.6%) and
Hong Kong (4.1%)
o Most traded currencies
▪ US$ (87%), Euro (33%), Japanese Yen (23%), Pound Sterling (12%) and
Australian$ (9%)
• The exchange rate (XR)
o the ratio of one unit of currency of country A to a unit of the currency of
country B at the time of the buy or sell transaction
o Commonly used terms in foreign exchange:
▪ Spot rate
▪ Forward rate
▪ Cross rate
▪ Bid
▪ Ask
• 1. Prime function is currency conversion
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o A gloal arket, ope 24 hours ad operatig aross different time zones
o Used by tourists, international firms paying for goods, firms investing in
international markets and financial institutions managing exposures
• 2. Speculation on currency movements
o Movement of funds from one currency to another in hope of profiting from
exchange rate movement
• 3. Hedging - insuring against the possible losses from unpredictable exchange rate
swings (the opposite of speculation)
o Spot exchange rates:
▪ Continually fluctuating
▪ Can be a problem if there is a time lag in payment or receipt
o Forward exchange rates:
▪ Two parties agree today to exchange currencies at a particular rate,
on a specified future date
▪ Can be used for hedging (insuring) against currency movement
o Forex swaps (using forward exchange) :
▪ An agreement to exchange currencies on a future date coupled with a
reversal of the exchange at a later date at agreed rates
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