Business finance : theory and practice

Chapter 15 • International aspects of business finance
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Interest rate parity = where nominal interest rates are different between countries,
the exchange rate will shift over time.
Exchange rate risk
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Transaction risk = problem that the exchange rate will alter during a credit
period leading to a loss. Can be tackled in various ways:
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Do nothing:
– On average, a business will gain as often as it loses from foreign
exchange movements.
– Dangerous strategy where averaging may not work, for example with a
particularly large or unusual transaction.
Trade in the business’s home currency:
– Often difficult to make sales in other than the customer’s home currency,
so there may be costs.
Maintain a foreign currency bank account:
– Use it to make payments and bank receipts in the foreign currency
concerned.
– Make transfers to and from it (by converting from or to home currency)
when the exchange rate is favourable.
– Ties up cash (may cause an opportunity cost), also difficult to judge
when rate is favourable.
Net transactions:
– Set payments for purchases against sales receipts in the same currency,
perhaps using a bank account in the currency.
– Requires equal and opposite transactions in the same currency, which
would be unusual – could work partially.
Use the forward market:
– Deal done today at an agreed (forward) rate, but the currencies are not
exchanged until a specified future date, when the foreign debt or obligation
is due.
– Advantage: business knows how much it will receive or pay in terms of
home currency.
– Disadvantage: business cannot gain from a favourable exchange rate
movement because it is committed to the foreign exchange transaction.
Use currency futures:
– Exactly the same as forward contracts, except they are for standard
amounts and dates, which means that there can be a market for them.
– Advantages: business knows how much it will receive or pay in terms of
home currency and futures can be bought and sold as required.
– Disadvantages: business cannot gain from a favourable exchange rate
movement because it is committed to the transaction and futures are
unwieldy (standardised amounts and dates).
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