1. Executive Summary
This paper discusses how companies are managing the foreign exchange risk through the use currency options. For instance, some companies who didn’t not take risk management seriously had resulted in inefficient use of capital, increased liabilities, and reputation risk. Moreover, a lack of certainty can cause confusion as to what a company’s acceptance of risk is, such as a level of acceptance. Without risk management, a company can become overconfident in its methods, which could lead to a financial crisis. The failure to objectively take risks leads to bad results like a company taking inappropriate risks not in the best long-term interests of the firm. Furthermore, poor risk management in finance could amount to …show more content…
In order to minimise the effect of the potential losses due to foreign currency exchange rate, it essential to understand the use of financial instrument.
Foreign exchange risk consists of three main types of exposures. First, transaction exposure is when a firm has a contractual obligation under which it supposed to receive or pay a certain amount in a currency that is different than its home currency. Transaction exposure has an effect of the firm’s income statement because the accounts payables or receivables can be affected by currency exchange rates. Second foreign exchange exposure is the translation which impacts the balance sheet of the firm. It occurs when consolidating financial statements of foreign units into a company’s home currency. The third type of foreign exchange exposure is the economic which influences a firm’s cash flows when exchange rates change. This type of exposure can impact assets, liabilities, or any type of anticipated foreign currency cash exchange.
The starting point of any foreign exchange risk management plan is to identify the exchange exposure faced. In controlling the foreign exchange risk, currency options have attained acceptance as very helpful tools due to their exclusive nature. They are very critical and convey a much wider range of hedging alternatives. Call options provide the right to the buyer to purchase the
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The Balance of Payments in India mainly relies on services exports, remittances and the course capital flows, both foreign direct investments (FDI) and FII. It is very essential that all market participants, such as banks and other intermediaries be provided with the wherewithal so that they can undertake a risk management in a way that is scientific. One of the ways to access domestic, foreign exchange markets is to hedge on the underlying foreign exchange exposures. In addition, the facilities that are available as the booking of forward contracts were included in the domestic forex market in order to evolve and acquire volumes and depth (Sumanth, 2012). Some of the newer hedging instruments have put in place swaps and options in the
2) Minimize the cost associated with the foreign exchange risk management strategy, i.e. the management and hedging costs
Investment on securities such as shares, debentures, bonds are profitable as well as exciting. It is indeed rewarding but involves a great deal of risk. Shapiro (2006) describes the emergence and growth of the market for derivative instruments can be traced back to the willingness of risk averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. Kawaller, the President of Kawaller & Company, LLC and Managing Director of the Kawaller Fund in Brooklyn, NY (2008) analysed the prevailing scenario and stated that currency risk is an inherent aspect of international commerce. Fortunately, for enterprises that function in this space-particularly for those that transact with counterparties
Currency exposures assume many forms: they can be assets or liabilities; current or committed; contracted or merely forecast; they can be for trade, investment or balance sheet purposes. Cases of currency exposure can emerge at any point along the value chain, with various repercussions. Each requires a transfer of funds, and for each the rate of exchange is uncertain. Examples of different types of currency exposures are presented below.
There are lots of methods to solve the changes in foreign currency and interest rates issue, however, derivative financial instruments are the major tunes Nike enterprise has used to tackle this issue. Despite the fact that this approach does not wipe out comprehensively the risk of foreign exchange, Nike enterprise still utilize it to minimize or delay the negative consequences. Specifically, the derivative financial instruments comprise embedded derivatives, interest rate swap, and foreign exchange forwards and options contracts (Nike annual report, 2014).
There is also risk of volatility with respect to exchange rates in the short and long term
Then, we took into consideration only a fluctuation of the exchange rate. The scenarios that we analyzed covers different positions of the dollar against the euro: weak dollar (USD 1,48/EUR), stable dollar (USD 1,22/EUR) and strong dollar (USD 1,01/EUR). Different coverage of costs with hedging was also introduced in the analysis. The three main policies are of not hedging, 100% hedging with forward contracts and 100% hedging with options.
This report is created with a discussion over several important international finance topics for instance, interest-rate parity, currency risk management, regarding description on Carrefour S.A. financing policies as well as hedging strategy. Additionally, we also discussed on which currency Carrefour should issue its 10-year, 750 million euro, annual coupon bond, its foreign currency risk exposure and a possible hedging decision in dealing with any or all of the identified risks.
After conduction an analysis, it shows that the fluctuations in exchange rate could cause a lot of trouble for GM. Hence, it reverts back to the issue of GM’s expectations of the future spot exchange rate. From this, they can then determine which hedging method is more
There has been significant changes in the international economy and politics that has led to uncertainty regarding the direction of foreign exchange rates that lead to volatility and the need to hedge foreign exchange rate risk and interest rate changes (Nobile, 2005). If a price is quoted ahead of time for a contract, the price may not be appropriate at the time of the actual agreement or the performance of the contract because of fluctuations in the foreign currency. The interest rate will have a differential between the two country currencies. A business or individual investor that buys foreign currency to purchase
What is exchange rate risk? An exchange rate risk refers to exchange rate fluctuations which can affect a firm’s profits and trade. For example, the euro exchange rate was $0.87 in 2002 but risen to $1.28 in 2012, so the cost in dollars increased by 47.1% over the 10 year period. This increase hurts the export of European products to the United States (Brigham & Ehrhardt, 2014). Also, the volatility of exchange rates incrases the uncertainty of the cash flows for a MNC. Because the cash flows are denominated in many different currencies, the dollar equivalent value of the company’s consoilidated cash flows also functuates (Brigham & Ehrhardt,
Foreign exchange risk management can be termed as the dangers taken into account while making any transactions in global financial markets. For example, if the US dollar currency is low and a company wants to sell goods to America, the buyer will pay in US dollar. This variation in
One thing which has been introduced with the emergence of currency derivatives, a participant with a foreign exchange exposure can find easy access to information over rates and future market expectations for the currencies traded. Benefits of trading in the currency futures segment are immense - from accessibility to price transparency and standardization, which in the case of over-the-counter trade is entirely different. As far as accessibility is concerned, currency derivatives offer an online electronic trading platform as opposed to the interbank forex market. In terms of price transparency, an online trading platform makes sure of uniform and real-time price access to all market participants, while in the OTC market one has to rely upon the rates offered by the bank. In
“Volatility would lead to a higher trading volume of currency options because of the higher potential gains and losses associated with greater exchange rate .Volatility and the resulting rise in risk management and speculative activities using options (Tan, 2000)”.
Great Eastern Toys is a company in Hong Kong that exports a huge percent of its total sales to the North American and European markets and hence is exposed to currency risk. Previously, the company was occupied with expanding their business and the company 's management had never given much attention to currency risk until their recent meeting with their banker. The banker pointed out that the depreciation of the European currencies during the previous two years had resulted in a substantial loss of income. The company 's management was indeed convinced that they should begin to devote more time and manage their currency position. In this report, we are going to explore the different options for Great Eastern Toys to hedge