Consolidation of financial statements, which involve foreign currency denominated assets and liabilities automatically, gives rise to translation exposure, sometimes termed as accounting exposure. Consolidation of foreign subsidiaries account into group financial statements denominated in home currency requires the application of a rate or rates of exchange to foreign subsidiaries accounts, in order that they may be translated into the parent currency. Both balance sheets and income statements must be consolidated and they both give rise to translation exposure. Translating foreign currency profit and loss accounts at either the average exchange rate during the accounting year or at the exchange rate at the end of the accounting year (both methods are currently permissible as per British accounting procedures) will mean that expected consolidated profit will vary as the average or that the expected closing rate changes. So the whole amount of profit earned in the foreign currency is exposed to translation Continue reading
Forex Investments
Forward Exchange Contracts
A forward exchange contract is a mechanism by which one can ensure the value of one currency against another by fixing the rate of exchange in advance for a transaction expected to take place at a future date. It is a tool to protect the exporters and importers against exchange risks. The uncertainty about the rate which would prevail on a future date is known as exchange risk. From the point of an exporter the exchange risk is that the foreign currency in which the transaction takes place may depreciate in future and thus the expected realization will be less in terms of local currency. The importer also faces exchange risks when the transaction is designated in a foreign currency. In this case the foreign currency may appreciate and the importer may be compelled to pay an amount more than that was originally agreed upon in terms of domestic currency. Continue reading
Fixed-Rate Currency Swaps and Currency Coupon Swaps
Fixed-Rate Currency Swaps A fixed rate currency swap consists of the exchange between two counter-parties of fixed rate interest in one currency in return for fixed rate interest in another currency. Following are the main steps to all currency swaps: Initial Exchange for the Principal: The counter-parties exchange the principal amounts on the commencement of the swap at an agreed rate of exchange. Although this rate is usually based on the spot exchange rate, a forward rate set in advance of the swap commencement date can also be used. This initial exchange may be on a notional basis of alternatively a physical exchange. The sole importance of the initial exchange on being either on physical or notional basis, is to establish the quantum of the respective principal amounts for the purpose of (i) calculating he ongoing payments of interest and (ii) the re-exchange of principal amounts under the swap. Ongoing Continue reading
Calculation of Exchange Rates for Forward Contracts
When computing exchange rates for merchant transactions, the cover or the base rate at which the cover transaction can be undertaken in the Forex market is first computed, thereafter the profit margin as allowed by the Foreign Exchange Dealer’s Association of India (FEDAI) is taken and the rate rounded off as per FEDAI Rule. In case of forward contracts, the procedure is similar except that while computing the base rate, the forward margin has to be appropriately taken. The forward margin is the extent to which the forward rate for a currency differs from its spot rate against a second currency. The forward margin when it tends to make a currency cheaper is called a ‘Discount’ while if it makes it costlier it is called a ‘Premium.’ Obviously if one currency is getting cheaper in the forward against another, the second should be getting costlier against the first. Thus while Continue reading
Comparison and Features of Future and Forward Markets
A Comparison Between Future and Forward Markets As a common trend and general preference, it is most unlikely that the investors would ever involve in the forward market, it is important to understand some of the attitudes, particularly as a good deal of the literature on pricing futures contracts typically refers to those contracts interchangeably. Specially differences resulting from liquidity, credit risk, margin, taxes and commissions could cause futures and forward contracts not to be priced identically. For example, in dealing with price risk, futures contracts have several advantages of transaction in comparison to forward contracts. Sequential spot contracts, which is also known as spot contracts where the terms of the contract are re negotiated as events unfold, do not inject any certainty into the transaction. Such a method of contracting is particularly liable to the hazards of opportunism and may deter investment because of the relatively high probability that Continue reading
Forward Foreign Exchange Contracts
Forward exchange is a device to protect traders against risk arising out of fluctuations in exchange rates. A trader, who has to make or receive payment in foreign currency at the end of a given period, may find at the time of payment or receipt that the foreign currency has appreciated or depreciated. If the currency moves down or gets depreciated the trader will be at a loss as he will get lesser units of home currency for a given amount of foreign currency, which he was holding. Similarly, an importer, who was contracted to make payment of a given amount in dollar at the end of a given period, may find that at the time of payment, the rupee dollar rate is higher. He would then have to pay more in rupees than what it would have been at the time when the contract was made. To protect traders Continue reading