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Direct Quotation Where the price of foreign currency is quoted in terms of home or local currency. In this system variable units of home currency equivalent to a fixed unit of foreign currency is quoted. For Eg - US$1 = Rs.45.30 Indirect Quotation Where exchange rates are quoted in terms of variable units of foreign currency as equivalent to a fixed unit of home currency.
are generally available and the customers have to enter in to specific contracts for forward rates.
Corporate entity point of view, currency exposure is the extent of vulnerability which will affect its profit and loss figures and Balance sheet resulting purely from the exchange rate movements. Hence in a Corporate business strategy, foreign exchange risk management assumes great significance.
parts :
exchange market has been subjected to full interplay of market forces. The transaction exposure would still increase if a long term trade agreement with a country has been entered in to and therefore the corporate would be not in the position to switch over its trade flow.
movement in exchange rate in either case would have its impact on domestic currency value of these transactions and if the exchange movements are wide and transactions are large it would have a serious impact on the financial position of the company. Between two Balance sheets dates, it may alter the net asset value and gearing ratio. In case of multinationals, the reported profits of overseas subsidiaries can be affected
by the change in the exchange rate at which profit figures are translated in to domestic currency.
Though this is not a direct foreign exchange risk exposure but the underlying economic factors may become a risk factor.
will move in its favor. Even if the company wants to adopt the policy of hedging everything, still economic exposure cannot be eliminated and this give rise to opportunity cost. If suppose the company hedged the exposure and if the spot rates moved in favor of the company due to shift in the economic factors between the date of invoice and conversion of currency, the company may lose out or incur and opportunity cost by hedging
the exposure if the rates moved against. Corporate Managers specially companies operating in several; countries have the advantage of containing the exposures by their own management techniques by Opening foreign currency accounts where there are receivables payable in the same currency (our Foreign Exchange regulations permit opening of foreign currency A/Cs in certain
cases).
Netting group exposure and reduce the risk by currency switches between asset and liabilities. In case of manufacturing companies, switch the base of manufacturer so that cost and revenue are in the same currency.
forward exchange contracts both for sale and purchase transaction to customer with a maturity date for a fixed amount at a determined rate of the exchange at the outset. Normally contracts are entered in India for a period where the maturity period of the hedge does not exceed the maturity of the underlying transaction. The customer has the option to choose the currency of the hedge and tenor. The option forward contracts are little more flexible in that the
customer can exercise the option during the option period on any day. The disadvantage of the forward contract is that rate is locked in but where the transaction has a fixed maturity date, forward contract are handy. Even if the customer wants to cancel the contract, he can do so subject to cancelation charges and interest on outlay of funds incurred by the bank, if any. Hence in case of fixed forward exchange contracts also there is a certain amount of
flexibility. As per current regulations in India, forward contracts involving rupee as one of the currencies, once cancelled shall not be re-booked although they can rolled over at ongoing rates on or before maturity. This restriction is not applicable to contracts covering export transactions which may be cancelled, rebooked, or rolled over at ongoing rate. Substitution of contracts for hedging trade transactions is also
Currency Futures :
A future contract is an agreement to buy or sell a standard quantity of specific financial instrument at a future rate and at an agreed priced. These are tailors made contracts and sold organized exchanges such Chicago international money market. A corporate can take an up a
future contract which is opposite to its foreign currency transaction exposure. However the future reviewed on a daily basis based on spot rates therefore the value of the future contracts varies depending upon the agreed price. Hence the resultant spot will determine the loss or gain on the transaction exposure and can be counter acted by the resultant loss or gain, on the future contracts, Now the drawback of the future contracts are :
This may not precisely meet the requirements of corporate which may result in a residual exposure either in respect of maturity dates or the amount. Also the loss in value arising out of revaluation may have to be adjusted in the margin posted in the exchange rate therefore cash flow in the corporate may be effected.
Currency Option :
Currency option gives the right
but no obligation to the buyer of the option to sell (put option) or buy (call option) a specific amount of foreign currency at a pre-determined price called strike price. As stated above there are tailor made options which can be picked up over the counters of the banks. The buyer of a option to pay a price premium for conferring the above right by the option writer i.e. banks. In an American option, option can be exercised at any time with in the period of option. In
case of European option, option can be exercised on the specified expiry date. As such American option is better, as it gives flexibility to exercise strike price. If a company believes that underlying exposure will result in a gain, currency option is useful and if the company insures against loss, the company has full hedge. As per current regulations in India, a resident is permitted to book and /or cancel freely a foreign currency option
contract with an authorized dealer to hedge foreign exchange exposure arising out of his trade subject to the specified conditions. In case of contingent pre- transaction exposure, like projects abroad where the company has to bid for a large contract determined in foreign currency, the company at the bid stage will not know whether the currency exposure will arise or not. If the bid materializes, company will exercise the option if the spot rate moves adversely and
will not exercise the option if spot rate is in favor. If the bid does not materialize, the option will be abandoned and sold back to the writer. Currency options are expensive then forward contracts as premium has to pay by the buyer .If option is not exercised and permitted to expire, the premium cost will be maximum or if it has still balance time-value some portion of premium can be retrieved. In India, RBI permits the contingent foreign
exchange exposure arising out of submission of a tender bid in foreign exchange for hedging.