BUSF_A01.qxd

Summary

lUse the spot market and a money market (borrowing or lending) hedge.

For example, business expecting a receipt in foreign currency at a known

future date should:

1 borrow (in the foreign currency) amount that will grow with interest to

the expected receipt amount;

2 exchange the borrowings for home currency immediately;

3 in due course, use the receipt exactly to pay off the loan.

• Advantage: conversion takes place at the time of the sale or purchase
  and rate is known.


• Disadvantage: cannot benefit from any favourable movement in the rate
  because forex transaction undertaken at the beginning.
  lBuy currency options – a right but not an obligation to exchange specified
  amounts of specified currencies on a specified date at a specified rate. For
  example, a business with a creditor to meet in a foreign currency in three
  months’ time should:
  1 buy a call option for the amount of currency and date concerned, at the
  best rate available;
  2 on the due date, exercise the option, if the rate specified in the option is
  better than the spot rate at that time, or, if the spot rate is better than the
  option rate, use the spot market and let the option lapse.


• Advantage: can benefit from a favourable shift in the rate – no obligation
  to exercise the option.


• Disadvantage: buying the option costs money.

lEconomic risk

lSimilar to transaction risk, but long term. Can be tackled in various ways:

• Strategic approaches, such as avoiding being too exposed in a particular
  currency.


• Currency swaps: two businesses with borrowings in different currencies
  agree to service each other’s debt, each in its home currency.

lTranslation risk

lPossibility that assets held abroad will lose value in the home currency with

an exchange rate movement and so the shareholders’ wealth reduced.

lCan be managed with strategic approaches.

International investment appraisal

lRaises problems additional to home country investment, for example assess-
ment and estimating future exchange rates, foreign taxes, inability to repatri-
ate investment returns.

International portfolio theory

lInternational security investment should increase the benefits of diversifica-
tion because returns from securities in different countries tend to be relatively
uncorrelated.