NTA UGC NET - Commerce: UNIT 04 - Business Finance (PART 04)

 

VIDEO LINK

 

UNIT 04

Business Finance

PART 04

 

Exchange rate system
Foreign Exchange rate risk and Exposure / Hedging techniques

 

========================== 

 

MCQ: Exchange rate system in which an initial target exchange rate is set and the actual exchange rate will be allowed to fluctuate in a range around that initial target rate
 

a. Fixed exchange rate system
 

b. Pegged exchange rate system
 

c. Flexible exchange rate system
 

d. Managed Flexible exchange rate system

 

--------------------------------------

 

Exchange rate system

Foreign exchange is the currency of a foreign country
 

Foreign exchange rate is the value of a nation’s currency expressed in terms of a foreign currency
 

Exchange rate system is a mechanism, procedure and institutional framework for determining exchange rate.
 

 

Type of exchange rate system

Fixed exchange rate (Official Parity)

Exchange rate is kept fixed by the government through the central bank.
 

Do not change according to market condition
 

Variant of fixed Exchange rate system – Pegged Exchange rate system

 

 

Flexible Exchange rate system ( Floating Exchange rate system) 

Exchange rate is determined by the supply and demand in the foreign exchange market
 

Exchange rate is determined by the operation of market force
Decrease in external value of domestic currency- Depreciation
Increase in external value of domestic currency – Appreciation

Managed Flexible Exchange rate system ( Managed Floating Exchange rate system) 

Also known as intermediate Exchange rate system / Dirty float
Hybrid exchange rate system

 

 

Foreign Exchange rate risk 

Risk due to frequent variation the exchange rate
 

This will affect the value of asset/liability or operating income of international firms operating in different countries and dealing with different currency
 

 

Foreign Exchange rate exposure 

Magnitude or extent to which the foreign asset/liability or income of global firm is affected by variation in foreign exchange rate

 

 

Types of Foreign Exchange Exposure

Transaction Exposure : 

Associated with import and exports
 

It is the risk of an exchange rate change between the transaction date and the subsequent settlement date.

 

Economic exposure ( Operating Exposure ) :

Arise by the effect of unexpected currency fluctuation on a company‘s future cash flows and market value.
Long term in nature

 

Translation exposure (Accounting exposure):
Arise from the effect of currency fluctuation on a company’s consolidated financial statements
 

 

Forex Risk Management Techniques

 

Forward Market Hedge 

Hedging is an action taken to mitigate fluctuation in prices.
Forward market is where you can buy and sell a currency, at a fixed future date for a predetermined rate.

 

Rollover Hedging
A technique through which the investor can extend a contract for the sale of a commodity

 

Currency Future
A contract to exchange one currency for another at a specified future date at a predetermined price 

 

 

Currency option

Derivative financial instrument
Gives the holder the right to buy or sell a fixed amount of underling foreign currency at a fixed exchange rate on a specified date.

 

Currency Swap

Agreement between two parties to exchange different set of cash flows in future.

 

=============================