Chapter 15 • International aspects of business finance
lInterest rate parity =where nominal interest rates are different between coun-
tries, the exchange rate will shift over time.Exchange rate risk
lTransaction risk =problem that the exchange rate will alter during a credit
period leading to a loss. Can be tackled in various ways:
lDo nothing:- On average, a business will gain as often as it loses from foreign
exchange movements. - Dangerous strategy where averaging may not work, for example with a
particularly large or unusual transaction.
lTrade in the business’s home currency: - Often difficult to make sales in other than the customer’s home currency,
so there may be costs.
lMaintain a foreign currency bank account: - Use it to make payments and bank receipts in the foreign currency
concerned. - Make transfers to and from it (by converting from or to home currency)
when the exchange rate is favourable. - Ties up cash (may cause an opportunity cost), also difficult to judge
when rate is favourable.
lNet transactions: - Set payments for purchases against sales receipts in the same currency,
perhaps using a bank account in the currency. - Requires equal and opposite transactions in the same currency, which
would be unusual – could work partially.
lUse the forward market: - Deal done today at an agreed (forward) rate, but the currencies are not
exchanged until a specified future date, when the foreign debt or obliga-
tion is due. - Advantage: business knows how much it will receive or pay in terms of
home currency. - Disadvantage: business cannot gain from a favourable exchange rate
movement because it is committed to the foreign exchange transaction.
lUse currency futures: - Exactly the same as forward contracts, except they are for standard
amounts and dates, which means that there can be a market for them. - Advantages: business knows how much it will receive or pay in terms of
home currency and futures can be bought and sold as required. - Disadvantages: business cannot gain from a favourable exchange rate
movement because it is committed to the transaction and futures are
unwieldy (standardised amounts and dates).