LECTURE 6

Foreign Exchange Management in

International Trade
Export-Import Theory, Practices, and Procedures
Belay Seyoum
3rd Edition (or newer)
Chapter 10

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EMBA Program, Fall 2020 Dept. of International Business
Lecture Overview
• Basics of Foreign Exchange Transaction
• Protections against Exchange Rate Risks
―Shifting the Risk to Third Parties
―Shifting the Risk to the Other Party

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EMBA Program, Fall 2020 Dept. of International Business
Foreign Exchange
• Foreign Exchange (forex or FX) is the trading
of one currency for another. For example,
one can swap the U.S. dollar for the euro.
• Firms involved in international business,
especially in export or import business,
need to convert currencies from/to
home/host country to host/home countries.

Export Import Process Saiful Islam

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EMBA Program, Fall 2020 Dept. of International Business
Foreign Exchange Market
• A place where foreign currency is purchased and sold
• It is used for
• Consummate commercial transactions by bank for its customer
• To maintain stability of national currency by central bank
• Currency speculations
• Others- foreign travel and purchase of foreign
stocks and bonds; foreign investment; receipt
of income such as interest, dividends, royalties, etc.

Export Import Process Saiful Islam

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EMBA Program, Fall 2020 Dept. of International Business
Foreign Exchange Rate
• The exchange rate is the rate at which one currency
is converted into another or is the number of units
of a given currency that can be purchased for one
unit of another currency.
• For example, if you traveled to USA today, you'd
find one taka is worth $0.01190. So if you hand
over an amount of BDT 8400, you will get $100.
Alternatively, if you have $100, you can covert it
into BDT. 8400. So, exchange rate is $1= BDT. 84

Export Import Process Saiful Islam

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EMBA Program, Fall 2020 Dept. of International Business
Foreign Exchange Rate
• Exchange Rate- Direct Quotation
• When the domestic currency is quoted per unit
of the foreign currency.
• In other words, it involves quoting in fixed units
of foreign currency against variable amounts of
the domestic currency.
• For example, in the Bangladesh, a direct quote
for the USD would be BDT. 84 = $1. Conversely,
in USA, a direct quote for U.S. dollars would be
$0.01190 = BDT. 1

Export Import Process Saiful Islam

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EMBA Program, Fall 2020 Dept. of International Business
Foreign Exchange Rate
• Exchange Rate- Indirect Quotation
• When quotation expresses the amount of foreign
currency required to buy or sell one unit of the
domestic currency
• An indirect quote is the opposite or reciprocal of a
direct quote
• For example, In Canada, the indirect form of quote
for UDS would be C$1 = US$0.9615 (i.e. 1/1.0400)
or in Bangladesh Tk. 1 = $0.0129

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EMBA Program, Fall 2020 Dept. of International Business
Determinants of Exchange Rate
• Foreign exchange rates are based on the supply and demand for
various currencies
• Demand & Supply is the derivatives (function) of the fundamental
economic factors and technical conditions in the market
• Fundamental Economic Factors: Balance of payments position, Interest rates,
growth in the money supply, inflation, etc.
• Technical Conditions: Confidence in the government and political stability

Export Import Process Saiful Islam

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EMBA Program, Fall 2020 Dept. of International Business
Impact of Exchange Rate Fluctuation
• Profound effect on international trade
• Make vulnerable to foreign exchange risks
• An obligation to accept or deliver a specified amount of foreign currency at a
future point in time
• Could either reduce the amount of their receipts or increase their
payments in foreign currency
• Change the amount of profit/ loss
• The impact of exchange rate risks is felt more by export-import
companies than domestic firms

Export Import Process Saiful Islam

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EMBA Program, Fall 2020 Dept. of International Business
Foreign Exchange Transactions
• Exchange Rate Related Transactions
• Purchase of goods and services whose
prices are stated in foreign currency, that is,
payables in foreign currency
• Sales of goods and services whose prices are
stated in foreign currency, that is,
receivables in foreign currency
• Debt payments to be made or accepted in
foreign currency

Export Import Process Saiful Islam

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EMBA Program, Fall 2020 Dept. of International Business
 Foreign Exchange Risk
Import

$5,000
If current exchange rate is $1 = 𝑇𝐾. 80, requires Tk. 400,000 to complete the transaction
If future exchange rate is $1 = 𝑇𝐾. 85, requires Tk. 425,000 to complete the transaction
Export Import Process Saiful Islam
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EMBA Program, Fall 2020 Dept. of International Business
Foreign Exchange Risk
Export

$10,000
If current exchange rate is $1 = 𝑇𝐾. 80, receive Tk. 800,000 from the transaction
If future exchange rate is $1 = 𝑇𝐾. 75, receive Tk. 750,000 from the transaction
Export Import Process Saiful Islam
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EMBA Program, Fall 2020 Dept. of International Business
Foreign Exchange Risk
• The possibility that unpredicted changes in
future exchange rates will have adverse
consequences for the firm
• We need to
• Identify the sources/categories of risks
• Adopt techniques to minimize those risks

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EMBA Program, Fall 2020 Dept. of International Business
Protection Against Exchange Rate Risks
1. Shifting the Risk to Third Parties

• Hedging in Financial Markets

• Spot and Forward Market Hedge
• Swap
• Other Hedging Techniques
• Guarantees and Insurance Coverage

2. Shifting the Risk to the Other Party

• Invoicing in One’s Own Currency

• Invoicing in Foreign Currency

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EMBA Program, Fall 2020 Dept. of International Business
1. Shifting the Risk to Third Parties
A. Hedging in Financial Markets
• Making an investment/ action to reduce the risk of adverse price movements
in an asset/ exchange rate
• Important Terms
• Spot Prices - Current foreign exchange rates
• Forward Prices- rate occurring at some time in the future
• Premium- If the currency in question is more expensive for forward delivery than for
ordinary spot delivery
• Discount- If it is less expensive for forward delivery than spot delivery

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EMBA Program, Fall 2020 Dept. of International Business
1. Shifting the Risk to Third Parties
A. Hedging in Financial Markets (Contd.)
• Salient points about hedging
I. Hedging is not always the most appropriate technique to limit foreign
exchange risks
II. Hedging does not protect long-term cash flows
III. Forward market hedges are available in a very limited number of currencies
IV. Hedging should not be used for individual transactions

Export Import Process Saiful Islam

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EMBA Program, Fall 2020 Dept. of International Business
1. Shifting the Risk to Third Parties
B. Spot and Forward Market Hedge
• Spot Transaction- foreign currencies are purchased and sold for immediate
delivery, that is, within two business days
• Forward Transaction- exchange currencies on a future date at an agreed-
upon exchange rate usually 1/3/4/6/12 months
• Forward market hedging does not require borrowing or tying up a certain
amount of money for a period of time- unlike Spot market hedging

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EMBA Program, Fall 2020 Dept. of International Business
1. Shifting the Risk to Third Parties
C. Swap
• A swap transaction is a simultaneous purchase and sale of a certain amount
of foreign currency for two different value dates
• the bank arranges the swap as a single transaction, usually between two
partners
• Swaps are used to move out of one currency into another for a limited period
of time without the exchange risk of an open position

Export Import Process Saiful Islam

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EMBA Program, Fall 2020 Dept. of International Business
1. Shifting the Risk to Third Parties
D. Other Hedging Techniques
I. Hedging Receipts Against Payables
― Firm that has receivables in foreign currency could hedge its receipts
against a payable to the same or another firm at about the same time
with no additional cost and without going through the foreign exchange
market
II. Acceleration or Delay of Payments
― Accelerate payments- domestic currency is likely to depreciate in terms
of the currency of its foreign supplier
― Delayed payments- foreign currency in which payment is to be made is
likely to depreciate in value in terms of the domestic currency

Export Import Process Saiful Islam

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EMBA Program, Fall 2020 Dept. of International Business
1. Shifting the Risk to Third Parties
E. Guarantees and Insurance Coverage
• Exporters require a guarantee by the importer, a bank, or another agency
against the risk of devaluation or exchange controls
• Certain types of insurance coverage are available against exchange controls
• In view of its high cost, hedging is a better alternative than insurance

Export Import Process Saiful Islam

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EMBA Program, Fall 2020 Dept. of International Business
2. Shifting the Risk to the Other Party
A. Invoicing in One’s Own Currency
• The requirement of payment or receipt for a transaction is in one’s (importer
or exporter) own currency, to shift the risk arising from currency fluctuations
to the other party
• Payment in one’s own currency
― Shifts the risk of devaluation to the other party
― Shift the risk of imposition of exchange controls by the government
against convertibility and repatriation of foreign currency

Export Import Process Saiful Islam

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EMBA Program, Fall 2020 Dept. of International Business
2. Shifting the Risk to the Other Party
B. Invoicing in Foreign Currency
• When payment is to be made in foreign currency, it is important to require
inclusion of a provision that protects the value of its receipts from currency
devaluation
• The establishment of an “Escrow Account” in a third country’s currency
(stable currency) from which payments will be made- protects from losses
due to depreciation of other one’s currency

Export Import Process Saiful Islam

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EMBA Program, Fall 2020 Dept. of International Business
Chapter Summery
Chapter 10

Foreign Exchange Protection Against

Transactions Exchange Rate Risk

Shifting the Risk to Shifting the Risk to

Issues
Third Parties the Other Party
Exchange Rate
Quotations
Foreign Exchange Market
Hedging
Determinants Invoicing in
Swap
Impacts Own currency or
Guarantees
Transactions Foreign Currency
Others
Foreign Exchange Risk

Export Import Process Saiful Islam

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EMBA Program, Fall 2020 Dept. of International Business
 End of Lecture 6
* All clipart, image and graphics are sourced from Google webpage

Export Import Process Saiful Islam

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EMBA Program, Fall 2020 Dept. of International Business