Chapter 15 • International aspects of business finance
home currency may deny the business the opportunity to buy from certain foreign
suppliers who are only prepared to invoice in their home currency.
The key point here is strength in the marketplace. If the business’s goods or services
are much sought after and in short supply, then foreign customers may well be pre-
pared to accept being invoiced in the seller’s home currency. Similarly, a foreign sup-
plier, eager to make a sale, may be prepared to invoice in the customer’s home
currency, against that particular supplier’s own normal practice. Even where the busi-
ness can persuade both suppliers and customers to deal with it exclusively in the busi-
ness’s home currency, this may be a costly strategy in that the foreign businesses may
expect the prices to compensate them for bearing the transaction risk.Maintaining a foreign currency bank account
If the business maintains a separate bank account in each of the currencies in which it
transacts foreign business, it may be possible to delay conversion until such time as
it judges the rate to be particularly favourable. For example, if a UK business has US
customers, it could open a bank account in US dollars and pay all dollar cash receipts
into it. The account would then generate interest until such time as the business felt
that the dollar was relatively strong, and converted the balance to sterling.
If a UK business tended to buy from US suppliers, it could convert some sterling to
dollars periodically, when sterling was relatively strong. This could then be paid into
an interest-bearing dollar bank account, to be used to make payments in dollars as and
when they arose.
A problem with this strategy is a loss of liquidity by having cash tied up in the for-
eign currency bank account when it might be needed elsewhere in the business. Also,
deciding on the best time to convert may be difficult. To the extent that the foreign
exchange market for the two currencies is efficient, there will be no time when the
business could be confident that the rate would, in the future, move in one direction
rather than the other.Netting the transactions
A business that trades both as a buyer and a seller in the same foreign currency may
be able to set receipts from sales against payments for purchases, perhaps best effected
by opening a bank account in the foreign currency. Even if precise netting were not
possible because, for example, receipts in the foreign currency exceeded payments,
only the balance would need to be converted.
In many ways this is almost the perfect solution to the problem, but it requires a
particular set of circumstances that will only rarely occur, to any significant extent, for
most businesses.Forward exchange contracts
Earlier in this chapter, the point was made that it is possible to enter a foreign
exchange contract today, at an exchange rate set today, where the currencies will not
be exchanged until a specified date in the future. For example, where a UK business
knows that it will receive $1 million in three months’ time, it can enter into a forward
exchange contractimmediately that will fix the rate of exchange and thus eliminate
transaction risk. The rate will be closely linked to the spot rate. If interest rates are
higher in the USA than in the UK, the rate will be at a discount to the spot price in ster-
ling for $1. If interest rates are higher in the UK, the price will be higher than (at a pre-
mium to) the spot price.‘