Foreign Currency Management and Exchange Risk Management and External Financing

1) Exchange risk
a) Spot Exchange Transactions
b) Forward Exchange Transactions
2) Exchange risk management
a) Forward market
b) Foreign currency swap
c) Arbitrage
I. Space Arbitrage
II. Time Arbitrage
d) Long term rollover cover
 Exchange Risk
The price payable to a foreign buyer can be in seller or buyer’s currency or an
international currency such s US $.
The seller may prefer another currency in the following cases...
1) If his own currency is depreciating rapidly in value.
2) His government prefers to have some other currency.
3) The seller himself wishes to make payment abroad, where another currency
is more acceptable.
The buyer will also have to purchase the necessary foreign exchange to make
payments.
An exchange rate represents the number of currency units of one currency that
can be exchanged for another country’s currency units.
Exchange rates are established for two types of transactions…
1) Spot Exchange transactions
2) Forward Exchange transactions
1) Spot Exchange Transactions
They occur when currencies are traded for immediate delivery.
2) Forward Exchange Transactions
They occur when purchases & sellers contracted to buy & sell currencies for
delivery at a future date.
In case of specific rate of exchange & at a specific future date.
 Exchange Risk Management
1) Forward Market
A company can protect itself against exchange rate fluctuations by use of
forward or future market.
One locks in the rate of exchange by entering into contract to buy specific
currency at specific time at a specific exchange ratio.
A future contract is a guarantee to obtain conversion at a specified exchange
rate.
2) Foreign currency swap
This is agreement between two parties to exchange one currency for another at
a simultaneous spot & forward transaction.
In swap deal buying & selling involves same currency of the same value at
different maturities.
a) Simultaneous purchase of currency on spot & its forward sale or vice versa.
b) Simultaneous purchase & sale, both forward for different maturities.
A foreign currency is said to be at a premium, if that currency is costlier under
the forward rate than under the spot rate.
When the foreign currency is cheaper in forward market than in spot market, it
is to be at a discount.
3) Arbitrage
It is a method of making profits from exchange dealings.
Arbitrage is a situation where a guaranteed profit can be made by purchasing &
selling a currency simultaneously is one or more foreign exchange markets.
Arbitrage profits arise because of …
a) The difference in exchange rates at two different exchange centers.
b) The difference due to interest yield, which can be earned at different
exchanges.
1) Space
Arbitrage
It is highly probable that when two markets are separated by physical
distance the exchange rates may vary.
This is a situation, when speculator executes two or more
simultaneous contracts to buy & sell currencies in two or more capital
markets for delivery on the same day.
2) Time
Arbitrage
Here an investor benefits by executing a spot and a forward contract
to buy & sell a currency.
4) Long term rollover cover
The major risk faced by a borrower of foreign currency is that of adverse spot
exchange rate fluctuations, from the time of borrowing to the time of repayment.

Financial Multinational Organizations
 External Financing
1) Commercial
Banks
This provides foreign currency loans for international operations as
they do for the domestic operations.
These banks also provide facility to over draw.
2) Discounting
of trade Bills
This is used as a short term financing method.
3) Eurocurrency
Markets
When the currency is deposited outside the country of origin, it is
termed as Eurocurrency.
4) Euro Bond
Markets
Eurobond market has emerged as another significant source of
capital.
Euro bands are primarily sold in countries other than that of the
country in whose currency the bond is denominated.
5) Development
Banks
EXIM Band in United States
6) International
Agencies
International Finance Corporation and World Bank assist developing
countries by financing projects in private & public sectors.

Modes of Payment in International Trade
Most of the transactions are performed on credit basis on account of the
following reasons…
1) Intensive competition & increase in number of sellers have given buyer the
option to purchase goods from seller who can offer him the most for his money.
2) Credit terms have become one of the most important factors in negotiating a
sale.
3) Credit insurance has reduced the risk of credit extension.
1) Open Account The seller debits the account of the importer whenever he
exports goods.
2) Consignment
sale
The exporter has selling agents abroad.
Sale is made by the agent for and on behalf of the exporter.
3) Deferred
payments
In case of expensive capital equipment or machinery.
The importer pays a part of the price in advance & another part
on receiving the shipping documents.
The unpaid balance is generally guaranteed by the importer’s
bank.
4) Bank transfers The importer makes payment to a local bank in home currency
which arranges for payment to the payee abroad in the currency
of his country.
a) Telegraphic
Transfer (TT)
It is also known as cable transfer.
Its correspondent branch telegraphically to pay money to the
payee abroad.
It is the quick mode of remitting funds. No stamp duty is payable
on such transfer.
b) Mail transfer
(MT)
The local bank is sent to its correspondent or branch by post or
mail, surface or air.
It also does not require any stamp.
In this case, delays in payment to the exporter who will charge
interest for the periods.
c) Banker’s draft
or cheque
A draft is issued at the request of the remitter.
5) Bills of
exchange
Bills are prepared in triplicate, each copy is known as a via.
In case of only one copy is made, it is called solo bill.
The documentary bill is sent by the exporter’s bank to its branch
or correspondent.
6) Letters of Credit This is the most common method of remittance used in the
export trade.
 Kinds of letters of Credit
1) General & special letters of capital.
A general letter of credit is one addressed by the issuing bank to the world
generally requesting that advance by made to a third person by any one to
whom it is shown.
A special letter of credit.
2) Open (Clean) and documentary letters of capital
An open letter of credit is one in which the issuing bank undertakes to honor the
bill draw under the credit without security of any documents.
Banker only at the request of customers of very sound financial position.
A documentary letter of credit is one in which the issuing bank undertakes to
honor the bill drawn under it only if it receives with it certain documents of title.
3) Fixed & revolving letters of credit
A fixed letter of credit – the issuing banker specifies the amount up to which
and the period in which beneficiary can draw one or more bills.
In case of revolving credit, the issuing banker specifies the total amount up to
which the bills drawn may remain outstanding at a time & not the total amount
up to which the bills can be drawn.
4) Revocable & irrevocable letters of capital
The issuing banker reserves to itself the right to concede or modify the credit at
any moment it likes without notice to the beneficiary.
A letter of credit, unless stated to be irrevocable, is presumed to be always
revocable.
An irrevocable letter of credit is one, which can not be withdrawn by the issuing
banker without the consent of the beneficiary.
5) Confirmed an unconfirmed letters of credit
A confirmed letter of credit is on where the advising banker of the exporter’s
country.
It is confirmation to an irrevocable credit.
The advising banker takes up on itself the liabilities as that of the issuing
banker.