Your firm has just landed a la

Your firm has just landed a large client contract in Germany andsecured an even larger supplier contract from Mexico. You are inthe automobile stereo sound system business with the Detroit AutoShow, your signature event (product, advertising, etc.), and apotential deal with the Chinese and Brazilians projected to besigned and sourced in March and July 2016, respectively. What doyou recommend your C-Suite consider and your risk management groupdo, if anything, about this increasingly international exposure?What financial instruments, if any, would be of help to your firm?Why is your firm even having this discussion?


The scanario mentioned above is a typical example ofInternational Finance. Decision aking becomes complicated whenmultiple curencies are involved and with different legalenvironment, accounting practices and expectations ofcustomers/suppliers.

There are various factors involved while dealing withInternational business, namely:

  • Foreign currency could appreciate/depreciate – Appreciationmeans more nmber of local currency are needed to buy same number offoreign currency. Depreciation is vice-versa.
  • Inflation & Exchange rate – Suppose, there is inflation inUSA, then price of American items would rise to foreign items.Foreign people would buy less American items. This would lead todecrease in supply of forign currencies.
  • Interest rate: Suppose, interest rate in USA increase, foreigninvvestore would invest in USA market, so supply of foreigncurrencies increase, Dollar appreciates.

In Foreign exchange markets (OTC), currency rates are negotiatedbetween 2 parties and is majorly dominated by transactions amongstbanks. Since in the above case, supplier is from Mexico and clientis from Germany, foreign currencies would be Mexican Peso and Eurorespectively. To avoid risks involved due to currency fluctuations,forward contracts can be used.

Forward contracts asthe name sugggests are the ones in whichforeign currency can be bought/sold on a future date with ratesdetermined now. They serve as hedging mechanism in Internationalbusiness.

There are various risks involved, namely:

  • Trasaction Exposure – This occurs whencontracts are denominated in foreign currency and are alreadyentered, but not settled. This can have impact on Cash Flow of theorganization. To avoid such risks, there is a concept called”Hedging”. It ensures stability to cash flows. But because ofhedging, thre could be a possibility of less profit, however withhedging adverse risks can beavoided.

To manage such risks strategically,risk can be shifted to counter party or risk can be shared. Bestway is to get money and pay money in local currency. This wouldaveoffsetting effect and hence netted. Other option is to share therisk so that neither party is at extreme loss.

  • Economic Exposure – When risk is involved dueto exchange rate fluctuations, there would be impact in Cash flow.Strategic way to manage this kind of risk is to diversify ie;spread geographically. This can reduce volatility of aggregate cashflows. Product differentiation would be great use as it can help incombating competition. Uncertainty can be avoided by cultivatinggood relationship with local vendors and reduce dependency onforeign vendors, Long-term contracts can be signed withsuppliers.
  • Translation Exposure – Also known as Balancesheet or Acounting exposure, occurs when financial statements aretranslated to domestic currency from foreign currency. To avoidthis risk, 4 methods are used – Current/Non current method,Monetary/Non-monetary method, Temporal and all Current.
    • Current/Non current method: Assets& liabilities are categorized on the basis of maturities andbased on that applcable exchange rates are determined.
    • Monetary/Non-monetary method:Categorized on the basis of Monetary/Non-monetary. Monetary itemsare receivable/payable and non-monetary items include physicalassets/liablities.
    • Temporal method:Variant of Monetary/Non-Monetary method. In this method, same typeof echangerate re used for carrying items in balance sheet.
    • All current method: Only currrentrates are used except equity or which historical rate is used.

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