Foreign Exchange Risk Management
–
–
A market where currencies are traded / exchanged with other currencies.A market where currencies are traded / exchanged with other currencies.–
–
Major players are banks, who also trade in on behalf of their customers as well.Major players are banks, who also trade in on behalf of their customers as well.–
–
Several large & small buyers and sellers.Several large & small buyers and sellers.–
–
Significant transactions are conducted using telephone / electronically.Significant transactions are conducted using telephone / electronically.–
–
There are others brokers / agents and There are others brokers / agents and companies as players.companies as players.•
•How to determine and quote the Rates?How to determine and quote the Rates? Forex Market
Forex Market
Foreign exchange market is highly competitive.Foreign exchange market is highly competitive.
This rate is This rate is primarily deterprimarily determined through the interaction of demand and supply.mined through the interaction of demand and supply.
Interest or deposit of different currencies.Interest or deposit of different currencies.
The exchange rate is the The exchange rate is the price of one currency quoted in price of one currency quoted in another currency.another currency.
Two type of Two type of currencies involved:currencies involved:
o
o Base CurrencyBase Currency o
o Variable CurrenciesVariable Currencies
Forex Market Forex Market
In Forex market the rate In Forex market the rate are quoted in terms of a are quoted in terms of a base base currency to several other variable currencicurrency to several other variable currencies.es.
When a dealer express rate as US $ / PKR, the this mean the rate When a dealer express rate as US $ / PKR, the this mean the rate of number of of number of PKR to 1 US $.PKR to 1 US $.
For example, US $ / PKR = 60, means that we need to exchange Rs. 60 (PKR) to get one dollar.For example, US $ / PKR = 60, means that we need to exchange Rs. 60 (PKR) to get one dollar.
Conversely, a rate expressed as PKR/US $ refers to a rate of number of US $ to 1 PKR.Conversely, a rate expressed as PKR/US $ refers to a rate of number of US $ to 1 PKR.
In this case we need to express the rate in terms of dollar. How many dollars we will surrender toIn this case we need to express the rate in terms of dollar. How many dollars we will surrender to get 1 Rupee= US$ 0.016667 to get 1 PKR.
get 1 Rupee= US$ 0.016667 to get 1 PKR. Bid & Offer Price
Bid & Offer Price •
•Banks and Forex dealers quote two rates for a single pair of currency.Banks and Forex dealers quote two rates for a single pair of currency. –
–BID PriceBID Price –
–Offer PriceOffer Price •
•Bid Price (Lower price)Bid Price (Lower price) –
–A price at A price at which the dealer will sell the vwhich the dealer will sell the variable currency.ariable currency. •
•Offer price (Higher price)Offer price (Higher price) –
–A price at which the dealer will buy the variable currency.A price at which the dealer will buy the variable currency.
•
•A dealer/bank may express PKR/US $ asA dealer/bank may express PKR/US $ as 0.01666 - 0.01679
0.01666 - 0.01679 •
•At $ 0.01666, dealer will sell us $ in exchange for PKRAt $ 0.01666, dealer will sell us $ in exchange for PKR •
•At $ 0.01679, dealer will buy us $ In exchange for PKRAt $ 0.01679, dealer will buy us $ In exchange for PKR
•
•The difference between Bid & Offer is calledThe difference between Bid & Offer is called “Spread”“Spread” •
•This represents the income of dealer. For small sum the spread will be high but very small for highThis represents the income of dealer. For small sum the spread will be high but very small for high
sum. sum.
Spot Rate & Forward Rate: Spot Rate & Forward Rate:
•
•Currency can be bought and Currency can be bought and sold sold using spot and using spot and forward.forward.
Spot Rates:
Spot Rates: It means trading now. “Now” normally is up to two It means trading now. “Now” normally is up to two days.days. Forward Rates:
Forward Rates: Buying or selling forward means trading now and settling claim at a future date. Buying or selling forward means trading now and settling claim at a future date.
LESSON 38
LESSON 38
Example Example
•
•Rates for PKR/US$ are quoted as follows:Rates for PKR/US$ are quoted as follows: • •Spot Spot 0.0166530.016653 – – 0.016660 0.016660 • •1 1 month month 0.0166480.016648 – – 0.016655 0.016655 • •3 3 months months 0.0166320.016632 – – 0.016641 0.016641 • •6 6 months months 0.0166060.016606 – – 0.016617 0.016617
Today is 4Today is 4thth January. A Pak company has to pay US$ 245,000 to a supplier at the end of week 1 of January. A Pak company has to pay US$ 245,000 to a supplier at the end of week 1 of April and want to fix exchange rate now.
April and want to fix exchange rate now.
What forward rate can be obtained for a currency transaction and what would the cost to PakWhat forward rate can be obtained for a currency transaction and what would the cost to Pak company?
company?
Solution Solution
That rate will be 0.016632That rate will be 0.016632
The cost to the company will be:The cost to the company will be:
245,000/0.016632 = PKR 14,730,299.38 245,000/0.016632 = PKR 14,730,299.38
For foreign currency rate’s calculation there are two factors underlined:For foreign currency rate’s calculation there are two factors underlined:
–
–
Demand and Supply of Demand and Supply of currency involvedcurrency involved–
–
Interest Rates of currenciesInterest Rates of currenciesForeign Exchange Risks Foreign Exchange Risks
Foreign Exchange Risk is divided into 3
Foreign Exchange Risk is divided into 3 categoricategories:es: 1 ) Transaction Exposure
1 ) Transaction Exposure 2 ) Translation Exposure 2 ) Translation Exposure