Foreign Exchange Risk Management for Businesses
Foreign Exchange Risk Management
Risk Attitudes
A firm can adopt different attitudes towards foreign exchange risk:
- Risk-Neutral: Accepts the inherent risk.
- Risk-Seeking: Aims to profit from favorable exchange rate movements.
- Risk-Averse: Uses hedging instruments like insurance contracts.
Hedging with Derivatives
Derivatives are contracts to buy or sell currencies at a future date and predetermined exchange rate. Forward contracts are a common hedging tool, allowing businesses to lock in exchange rates and mitigate potential losses. Key terms include:
- LIBOR (London Interbank Offered Rate): Interest rate for Eurocurrency loans between London banks.
- Eurocurrency: Any freely convertible currency deposited in a bank outside its country of origin.
- EURIBOR (Euro Interbank Offered Rate): Euro interest rate.
Managing Export Collections and Insurance
Export insurance can be canceled upon successful receipt of foreign currency payments. Different scenarios require specific actions:
- On-Time Collection: Deposit the currency to cancel the insurance.
- Advance Payment:
- Place the currency in a deposit account.
- Negotiate early insurance termination with the bank.
- Sell the currency in the spot market (consider risk tolerance).
- Delayed Recovery:
- Negotiate an insurance extension.
- Buy foreign currency in the spot market to settle the insurance or obtain a new policy.
- Default: Cancel the insurance and manage the consequences.
Currency Options
are a hedging mechanism for change. The purchase of an option on currency gives the right but not the obligation to buy (call-option) or sell (put-option) a currency at an agreed exchange rate (strike price) during a period of time or a predetermined date , on payment of a premium to pay the option buyer at the time of acquisition. The option is a right to the owner, not an obligation. The seller either purchase or sale must comply with the agreement if the buyer decides to exercise the option. If the option expires at maturity.
American and European options when the exercise of the option or not can only be made on the due date, we are talking about an option europea.La American option is one that can be exercised at any time during the term of the option.
Currency futures Currency futures are negotiated agreements on an exchange or organized market for the purchase or sale of a standardized amount of a commodity or financial. Delivery must occur in a predetermined time and place. A futures contract is an agreement other than a firm and option, subject to the will of the exercise of buyer.
On establishing a security as a deposit, which is subject to daily settlement based on the oscillation of the changes.In the futures market only traded most traded currencies in the world, the strongest. Due to standardization, negotiated amounts not exactly fit the individual needs of usuarios.Son many major companies that regularly traded in futures and they have their own ‘brokers’, while medium and small companies, whether to buy or sell futures, they must use the channels of a bank and ‘broker’ in the bag tied to entidad.La clearinghouse that ensures that every part of the contract complies with its obligations. Credit risk will assume the stock is secured by a cash deposit (between 1% and 5% of the value of contracts). Every weekday, the exchange establishes a settlement price for futures contracts. Such daily closing prices are used to evaluate the positions for each account in future members of the clearinghouse. If the account value has increased from the previous day is credited as a profit, otherwise they incur losses.
Currency The currency is any encryption means of payment in a currency other than national, whether checks, checks, transfers, etc. And foreign legal money either coins or bills. The difference between ticket and currency is that those tickets are valued higher than the currency because they are susceptible to theft, loss, breakage and counterfeiting is a distinction between the ticket and currency exchange, ticket change refers to the paper money and currency transfers, checks, etc.
PROBLEM: The bank is clear from … … USD EUR for purchasing, and it has a financial cost. The bank finds that it is in USD … … Osios up within days. What will be Colca deposit those dollars in cost for … days. To make sure change the bank has the iguiente cost.