I need the following answered in simple layman's terms. I do need thurough answers with links to specifics when available. Thanks in advance for your efforts.
1: How do global companies protect themselves against foreign exchange risk and other financial risks?
2: How do U.S. multinational organizations finance their global operations?
3: What is the function of the foreign exchange market? Who are the market participants?
4: Why is it important for a global business to conduct a risk analysis? In a country risk analysis, which factors carry more weight than others? Does this hold true for all countries?© BrainMass Inc. brainmass.com October 24, 2018, 7:32 pm ad1c9bdddf
How do global companies protect themselves against foreign exchange risk and other financial risks?
Global companies protect themselves against foreign exchange risks arising due to fluctuations in exchange rates by using various hedging mechanisms avaiable in the financial markets such as currency futures, interest rate swaps, call and put options and forward contracts. These tools act as an insurance on the exchange rates and can be obtained by spending reasonable amounts. The downside of risk is limited when such instruments are used by the companies.
Other financial risks such as credit risks can be mitigated by conducting a thorough credit review and background check of the the other parties iinvolved in foreign transactions. Similarly, risks arising due to changes in government policies, economic and political changes, changes in export-import and repatriation laws of the countries in question, etc. can be mitigated or avoided by conducting thorough analysis and study and consultation with exzperienced professionals before entering into an international transaction and business.
How do U.S. multinational organizations finance their global operations? ...
Forex, Global corporations, risks
Strategies in Addressing Foreign Exchange Risk :
Businesses and governments adopt various strategies to minimise or take advantage of Foreign Exchange fluctuations. It is very important since the volume of transactions are huge involving millions of US dollars. The fluctuation of currency of one country in terms of dollars decides the amount of payment or receipts are to be made or received.
Discuss types of foreign exchange risk and strategies to address them.
The types of risks may be enumerated as follows:-
i) Transaction risk;
ii) Economic risk;
iii) Translation risk.
Hedging transaction risk - the internal techniques:
1) Invoice in home currency;
2) Leading and lagging;
4) Decide to do nothing;
Hedging transaction risk - the external techniques:
a) Forward contracts;
b) Money market hedges;
c) Future contracts;
e) Forex swaps; and
f) Currency swaps.
Hedging transaction risk - the internal techniques;
Invoice home currency: an easy way is that company insists its foreign customer pay in the company's home currency and likewise the company will pay for all for imports in home currency. But it does not eliminate the exchange rate risk. It has simply been passed on to customers. The adverse effect of it is that the customers may not be too happy and start looking for an alternative supplier.
However the exchange-rate risk has not gone away, it has just been passed onto the customer. Your customer may not be too happy with your strategy and simply look for an alternative supplier.
Leading and lagging: If an importing company foresees that currency in which the payment is to be made may depreciate it may delay in the payment with the consent of the customer/exporter or by extending the terms of the credit. Conversely if the exporter anticipates the currency is likely to depreciate over a period of time it may try to obtain the payment early by extending a discount.
Here the problem arises in guessing which way the movement of the rate will take place.
Matching: if the company's receipts and payment are due in the same currency and at the same time, it can easily match them against each other. Then there remains the problem of unmatched portion of the total transaction necessitating dealing on the Forex markets. One way to overcome this problem is to have a foreign currency account with a bank.
Decide to do nothing: in such situation the company will win or lose some. Theoretically the gains and losses let off to leave a similar result like that of hedged.
While in the short term the losses may be substantial, the additional advantage may be by way of saving in transaction costs.
Hedging transaction risk - the external techniques:
Forward contracts: The forward market is where a firm can buy and sell a currency, at a fixed future date at a predetermined rate, i.e. the forward rate of exchange. This effectively fixes the future rate.
Money market hedges: Here the company deposits/borrows the foreign currency till the date the actual transaction takes place avoiding the uncertainty of the future exchange rate by making the exchange at today's rate.
Futures contracts - The purpose of the future contract is to fix and exchange rate at some future date depending on the basic risk. The future contracts are traded in hedging instruments of standard size.
Options: An option is a right without imposing any kind of obligation to buy or sell a currency at existing price on a future date. In the event of favorable movement in rates the company may allow the option to lapse to take advantage of favorable movement.
The right is exercised only when there is an adverse movement. The difference between call option and put option is that in the case of former the holder has the right to buy the underlying currency and in the latter the holder has a right to sell the underlying currency.
The options are more expensive than the forward contracts and futures.
Companies use options when the need to cover exposure is over a long period of time extending from six to twelve months.
Forex swaps: In Forex swaps the parties agree to swap equivalent amount of currency for a particular period and then re-swap them at the end of the period at an agreed swap rate. The rate of swap and the amount of currency is agreed in advance by the parties hence called a fixed rate or a fixed rate swap. The objective of the Forex swap is to hedge against Forex risk for longer period than on the forward market. Besides it enables access to capital markets from where it may be very difficult to borrow directly - almost impossible.View Full Posting Details