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International Business

Currency convertability

Recap

Relative monetary growth, relative inflation rates and nominal interest rates differentials are all moderately good predictors of longterm changes in exchange rates They are poor predictors of short term changes in exchange rates This is because of the impact of Psychological factors, investor expectations and bandwagon effect

Currency convertability

Freely convertible: when a countrys govt. allows both residents and non-residents to purchase unlimited amounts of foreign currency with the countrys currency Externally convertible: When only nonresidents may convert local currency in to foreign currency without any limitations Non-convertible: When neither residents nor Non-residents are allowed to convert local currency to foreign currency

Implications for business

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It is critical that international businesses understand the influence of exchange rates on the profitability of trade and investment deals Adverse changes in exchange rates can make apparently profitable deals unprofitable Foreign exchange risks are divided into three categories: Transaction exposure Translation exposure Economic exposure

Implications for business

Transaction exposure is the extent to which the income from individual transactions is affected by fluctuations in foreign exchange values Example: suppose an Indian company has agreed to buy one Airbus 330 for a price of USD 100 mil, two years ago and gets delivery today Two years ago the Rupee USD exchange was Rupees 45 per 1 USD the cost in rupees would have been 4500 mil ( 450 cr) The actual exchange rate today is Rupees 52 per 1 USD so the company now has to pay 5200 (520 cr) mil Indian Rupees

Implications for business

Translation exposure is the impact of currency rate changes on the reported financial statements of a company It is basically concerned with the present measurement of past events The resulting accounting gains or losses are said to be unrealised- they are paper gains or losses But they have a significant impact a companys ability to borrow, cost of borrowing, stock price and access to capital markets

Implications for business

Economic exposure is the extent to which a firms future international earning power is affected by changes in exchange rates Economic exposure is concerned with the long term effect of changes in exchange rates on future prices, sales and costs

Reducing Transaction and translation exposure


We have already discussed forward exchange rate contracts and currency swaps Lead strategy: involves collecting foreign exchange receivables from customers early when a particular currency is expected to depreciate and paying foreign currency before they are due if that currency is expected to appreciate Lag strategy: Involves delaying collection of foreign currency receivables if that currency is expected to appreciate and delaying payables if the currency is expected to depreciate Leading and lagging involves accelerating payments from weak currency to strong currency countries and delaying inflows from strong currency to weak currency countries These strategies are difficult to implement as most firms are not really in a position to dictate these kind of terms But these are workable strategies when we are dealing with foreign subsidiaries There are also restrictions imposed by govt. on leading and lagging

Steps for managing foreign exchange risk


Centralised control of exposure is needed to protect resources efficiently and ensure that each sub unit adopts the correct mix of tactics and strategies, and guidelines have to be set for all to follow Firms should distinguish between transaction and translation exposure on the one hand and economic exposure on the other Firms need to look actively at forecasts of foreign exchange movements, though this is not a perfect science these forecasts are very good indicators Firms have to establish good reporting systems so that the central finance function can regularly monitor the firms exposure Finally, on the basis of the information it receives from forecasts and its own regular reporting systems, the firm should produce monthly foreign exchange exposure reports These reports should identify how cash flows and balance sheet elements might be affected by forecasted changes in exchange rates, so that they can be used by management to look at hedging against these movements

Improving export performance

One major impediment to firms actively looking at exports is lack of knowledge about foreign opportunities Several opportunities have now been created by govt. now for this purpose Trade fairs, data base in the commerce ministry, export promotion councils, commercial attaches in embassies etc. There are also export management companies that help in setting up export operations

Improving export performance

The best way to enter a market once you have the information is: Enter on a small scale to reduce risks or use importers in similar product lines Add additional products once you are established in the market Hire locals for promotion of the products

Steps in exporting

Identify Importer or establish your own company Quotation Contract Letter of credit Export Export documents Submit to bank Get payment

A typical export trade transaction


An US importer places and order with the Indian exporter and agrees to open an L/C The Indian exporter accepts the order and specifies relevant terms and conditions The US importer applies to his bank for a L/C to be issued in favour of the Indian exporter for the merchandise that he wants to buy The US bank issues a L/C on behalf of the US importer and sends it to the Indian exporters bank The Indian bank advices the exporter of the opening L/C in his favour The exporter ships the goods to the importer on a common carrier. An authorised official of the carrier gives the exporter a Bill of Lading (B/L) The exporter presents the documents as mentioned in the L/C to his bank along with a draft drawn on his bank The exporters bank send all the documents to the importers bank after verification The importers bank accepts the documents, verifies them The bank then informs the importer about the receipt of documents The importer makes payment to his bank and collects the documents to clear the goods The importers bank makes a wire transfer to the exporters bank in the currency that is specified in the L/C The exporters bank receives the payment and then converts it in to local currency and credits the exporters account

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