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Why is an exporter worried about fluctuating foreign exchange rates?

1. Why is an exporter that is to be paid in six months in a foreign currency worried about fluctuating foreign exchange rates?

2. Are there ways in which this exporter can protect itself? If so, what are they?

3. How does the credit or money market hedge work?

4. Why is acceleration or delay of payments more useful to an IC than to smaller, separate companies?

5. How would you accomplish exposure netting with currencies to two countries that tend to go up and down together in value?

6. Why is the price adjustment device more useful to an IC than to smaller, separate companies?

7. Some argue that translation gains or losses are not important so long as they have not been realized and are only accounting entries. What is the other side of that argument?

8. Is the parallel loan a sort of swap? How does it work?

9. How and why would a seller make a sale to a buyer that has no money the seller can use?

10. Developed country partners in countertrade contracts have had problems with quality and timely delivery of goods from the developing country partners. How are they trying to deal with those problems?

Solution Preview

1. Why is an exporter that is to be paid in six months in a foreign currency worried about fluctuating foreign exchange rates?

The exporter is worried about fluctuating foreign exchange rates because fluctuations on the adverse side can significantly affect the amount he is due to receive in the transaction and thus, negatively affect his revenues and profitability. For example, if he has exported to Europe and within these six months, dollar strengthens against the Euro, then it means that he will be receiving less amount in US dollars for his export as compared to his original expectation.

2. Are there ways in which this exporter can protect itself? If so, what are they?

Yes, exporter can protect itself by utilizing one of the various hedging options available in the internatial financial markets, such as currency forwards or futures contracts, options such as put and call options, interest rate swaps,etc. These hedging mechanisms will limit the downside risk involved in the transaction by spending a small amount on these instruments.

3. How does the credit or money market hedge work?

A money market hedge?called that way because it necessitatesborrowing or lending in the short-term money market?enables acompany with a future receivable or a future payable to make the
required exchange of currencies at the current spot rate. Forexample, suppose a U.S. exporter expects to receive four millionBrazilian reals in one month from a Brazilian customer. The busi-ness could eliminate uncertainty about the rate of currencyexchange by borrowing reals in Brazil at an interest rate of 10 per-cent per month: The company can convert the reals into U.S. dol-lars at the spot rate. When the Brazilian customer pays the million reals one month later, it is used to pay off the principle andinterest accrued on the loan in Brazil.

source: http://www.vsb.org/publications/valawyer/june_july01/kelley.pdf.

4. Why is acceleration or delay of payments more useful to an IC than to smaller, separate companies?

Acceleration or delay of payments can be more useful for an international company involved in multi currency transactions because fluctuations or movements of the currency on the favorable side can result in abnormal profits, which is not possible in the case of smaller companies as they deal in one currency only.

5. How would you accomplish exposure netting with currencies to two countries that tend to go up and down together in value?

If one believes that exchange rate movements of two currencies are highly positively correlated, ie, they tend to go up or down together in value, then a short position in one currency will largely offset a long position in the other currency and thus exposure netting can be ...

Solution Summary

This solution discusses why an exporter that is to be paid in six months in a foreign currency is worried about fluctuating foreign exchange rates. The solution addresses each question as well as discusses a number of motivations for active management of translation exposure for question 7. This solution is 1473 words with online sources.

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