Managing Transaction Risks

1. Managing Transaction Risks

2. Currency dispute (?) http://www.youtube.com/watch?v=E6occEOoTzY • Interest rate parity (good) • http://www.youtube.com/watch?v=Lt6W4Jy10FQ • International fisher effect • http://www.youtube.com/watch?v=XS5Utaati60 • Purchasing power parity • http://www.youtube.com/watch?v=4d4bWXyfXBk

3. Managing Transaction Risks Currency of Quote Currency Exchange Rates Exchange Rate Determinations Exchange Rate Forecasting Managing Transaction Exposure International Banking Institutions Currency of Payment as a Marketing Tool

4. Managing Transaction Risks Currency of Quote Currency Exchange Rates Exchange Rate Determinations Exchange Rate Forecasting Managing Transaction Exposure International Banking Institutions Currency of Payment as a Marketing Tool

5. Currency of Quote Factors Affecting the Choice of Currency for a Transaction • The risk of currency fluctuation • The convertibility of the currency

6. Risk of fluctuation • Aug 20: 1 euro = 1.27 dollars • Aug 20: $10000 in iPod accessories (€ 7874.02) • Oct 2: 1 euro = 1.15 dollars • Actually collection = $9055.12 • Difference of $944.88

7. Currency of Quote Factors Affecting the Choice of Currency for a Transaction • The risk of currency fluctuation • The convertibility of the currency

8. Currency of Quote Convertible of the Currency • Hard Currency  A currency that can be converted into another currency. • Soft Currency A currency that cannot be converted into another currency or that cannot easily be converted into another currency.

9. Currency of Quote Exporter's Currency • The exporter and the importer agree that the currency of the transaction will be the currency of the exporter's country. • All of the currency exchange risks are borne by the importer. • The possible convertibility problems of the currency are to be resolved by the importer.

10. Currency of Quote Importer's Currency • The exporter and the importer determine that the currency of the transaction will be the currency of the importer's country. • All of the currency exchange risks are borne by the exporter. • The possibility convertibility problem will have to be resolved by the exporter.

11. Currency of Quote Third Country's Currency • The exporter and the importer agree that the currency of the transaction will be a third country's currency. • They each bear the risks of currency fluctuation of their respective country's currency against the currency of the transaction. • Most commonly used third country’s currencies are the U.S. dollar, the European euro, the British pound, the Japanese yen and the Swiss franc. • A third country’s currency can also be an artificial currency (a currency not in circulation), such as the SDR of the International Monetary Fund.

12. Currency of Quote Third Country's Currency • Special Drawing Right (SDR) • After the euro was changed into a circulating currency on January 1, 2002, it is the only artificial currency. • Its value is determined by the value of a basket of four currencies: the euro (approximately 34 percent of the SDR’s value), the Japanese yen (approximately 11 percent), the U.S. dollar (approximately 44 percent), and the British pound (approximately 11 percent).

13. Special drawing rights • http://www.youtube.com/watch?v=SRedLWqA8FY

14. Currency of Quote The Euro • The common currency of 16 of the twenty-five countries of the European Union are: • Austria, Belgium, Finland, France, Germany, Greece, Italy, Ireland, Luxembourg, the Netherlands, Spain and Portugal • It was developed in the late 1990s as an artificial currency based on the values of the historical currencies of six of the European countries, and placed in circulation on January 1, 2002.

15. European Currency Unit

16. Value of the Euro to Previous National Eurozone Currencies on January 1, 2002 Currency of Quote

17. European Countries That Have Not [Yet] Adopted the Euro Currency of Quote

18. The Euro Currency

19. Managing Transaction Risks Currency of Quote Currency Exchange Rates Exchange Rate Determinations Exchange Rate Forecasting Managing Transaction Exposure International Banking Institutions Currency of Payment as a Marketing Tool

20. Currency Exchange Rates • Types of Exchange Rates • Types of Currencies

21. Euro vs Dollar

22. Exchange rate 1.29 1.25

23. Currency Exchange Rates Types of Exchange Rates • Direct Quote  • The value of a foreign currency expressed in units of the domestic currency; for example, the euro is worth $1.31 as of December 15, 2006. • Some currencies are traditionally expressed as direct quotes. • Indirect Quote   • The value of the domestic currency expressed in units of the foreign currency; for example, the dollar is worth 117.83 yen as of December 15, 2006. • Some currencies are traditionally expressed as indirect quotes.

24. Currency Exchange Rates Types of Exchange Rates • Inverse Relationship Between Two quotes:

25. Currency Exchange Rates Types of Exchange Rates • Spot Exchange Rate  The exchange rate of a foreign currency for immediate delivery (within 48 hours). • Forward Exchange Rate The exchange rate of a foreign currency for delivery in 30, 90, or 180 days from the date of the quote.

26. Spot rate link • http://www.x-rates.com/

27. Currency Exchange Rates Types of Exchange Rates • Spot Exchange Rate  The exchange rate of a foreign currency for immediate delivery (within 48 hours). • Forward Exchange Rate The exchange rate of a foreign currency for delivery in 30, 90, or 180 days from the date of the quote.

28. Currency Exchange Rates Types of Exchange Rates • European euro -- U.S. dollar spot and forward exchange rates on December 15, 2006 (direct rate): Spot $ 1.3093 30-day forward $ 1.3135 60-day forward $ 1.3215 90-day forward $ 1.3285

29. Currency Exchange Rates Types of Exchange Rates • U.S. dollar -- Japanese yen exchange rate on December 15, 2006 (indirect rate): Spot ¥ 117.83 30-day forward ¥ 115.35 60-day forward ¥ 113.41 90-day forward ¥ 112.37

30. Currency Exchange Rates Types of Exchange Rates Methods to quote a Forward Exchange Rates • Outright Rate • The outright rate is the rate at which a commercial customer would purchase the currency. • Swap Rate  • The swap rate is the difference between the current spot rate and the rate at which a commercial customer would purchase the currency. • It is expressed in points that must be subtracted or added to the spot rate. • The swap rate is the method used by banks and other financial institutions to express a forward exchange rate.

31. Currency Exchange Rates Types of Exchange Rates • U.S. dollar -- Japanese yen exchange rate on December 15, 2006 (indirect rate): Spot ¥117.83 0.00 30-day forward ¥115.35 2.48 60-day forward ¥113.41 4.42 90-day forward ¥112.37 5.46

32. Currency Exchange Rates Additional Types of Exchange Rates • Currency Futures The exchange rate for a fixed amount of currency, delivered at a fixed date in the future • A currency futures’ contract is an agreement between two parties: • The seller (called the "short") who promises to deliver the currency on a certain date, and • The buyer (called the "long") who agrees to buy the currency at a price which is agreed upon ahead of time

33. Currency Exchange Rates Additional Types of Exchange Rates • Difference Between Futures' Contract & Forward Contract • The amount of the foreign currency for which a company can purchase futures is fixed, in contrast with the forward market, in which any given amount can be purchased or sold • The date at which the future has to be settled (purchased or sold) is fixed, in contrast with the forward market, in which any given date can be chosen in advance.

34. Currency Exchange Rates Additional Types of Exchange Rates • Currency Options    • A method generally used to speculate on the value of a currency in the future • A firm can purchase options to buy (called call options) or options to sell (called put options) a particular currency at a particular price, called the strike price, on a given date. • The complexity of the options’ market is substantial.

35. http://www.youtube.com/watch?v=EH9RjItbR00 • Options

36. HSX

37. Currency Exchange Rates Types of Currencies • Floating Currency  • A currency whose value is determined by market forces: the exchange rate of a floating currency varies frequently • A currency is floating does not always represent unpredictability: most of the developed countries have currencies that are comparably stable • Currencies are sometimes “assisted” by their country's government to sustain the value of a currency.

38. The euro/U.S. Dollar Exchange Rate, January 1999-June 2006

39. Currency Exchange Rates Types of Currencies • Pegged Currency • A currency whose value is determined by a fixed exchange rate with another, more widely traded currency • As the value of the reference currency fluctuates, so does the value of the pegged currency, but the exchange rate between the two remains constant. • Currency Bloc • A group of currencies whose values fluctuate in parallel fashion • The currencies within the group have a fixed exchange rate, but their exchange rates with currencies outside of the group float.

40. Currency Exchange Rates Types of Currencies • Dollarization  • A phenomenon where other countries decide to adopt the U.S. dollar as their circulating currency • Panama and Ecuador have gone through a “dollarization” of their respective economies. • Artificial Currency • A currency that is not in circulation • After the euro was changed into a circulating currency on January 1, 2002, the only artificial currency left was the Special Drawing Right of the International Monetary Fund, whose value is determined by the value of a basket of four currencies: the European euro, the Japanese yen, the U.S. dollar, and the British pound.

41. Managing Transaction Risks Currency of Quote Currency Exchange Rates Exchange Rate Determinations Exchange Rate Forecasting Managing Transaction Exposure International Banking Institutions Currency of Payment as a Marketing Tool

42. Exchange Rate Determinations Purchasing Power Parity • An economic theory that holds that exchange rates should reflect the price differences of each and every product between countries. • The idea is that a set amount of money (regardless of the currency in which it is expressed) would purchase the same goods in any country of the world. • It is determined by using a “basket of goods” and calculating how much domestic currency an average person would have to spend to purchase that basket of goods. • It is effectively calculated using inflation rates.

43. The Big Mac Index

45. Exchange Rate Determinations Purchasing Power Parity • An economic theory that holds that exchange rates should reflect the price differences of each and every product between countries. • The idea is that a set amount of money (regardless of the currency in which it is expressed) would purchase the same goods in any country of the world. • It is determined by using a “basket of goods” and calculating how much domestic currency an average person would have to spend to purchase that basket of goods. • It is effectively calculated using inflation rates.

46. http://www.youtube.com/watch?v=txhr1VVph0E&feature=related • Purchasing power parity video

47. Exchange Rate Determinations Purchasing Power Parity

48. Purchasing Power Parity

49. Exchange Rate Determinations Fisher Effect • An economic theory that holds that the interest rates that businesses and individuals should pay to borrow money should be uniform throughout the world. • The nominal interest rates that they actually pay in a given country is composed of this common interest rate and the inflation rate of that country.

50. Fisher effect • http://www.youtube.com/watch?v=zLM9NjN7ano