Foreign Exchange Market

Tutorial 9 Presentation Questions (Foreign Exchange Markets)

1. Describe the main types of risk facing an organization which has dealings in a foreign currency. Can all these risks be hedged, and should all these risks be hedged at all times ?

The main foreign exchange risks faced by the organization include :

* Short-Term Exposure

* The day-to-day fluctuations in exchange rates.

* Can be reduced or eliminated probably by the use of forward & futures exchange agreements, and other derivatives.

* Long-Term Exposure

* Usually comes from the unanticipated changes in relative economic conditions.

* Hedging is usually more difficult. One reason is that organized forward markets are not established for long-term needs.

* Translation Exposure

* An accounting issue when a company needs to calculate its accounting net income when foreign operations or transactions are involved.

The foreign exchange risk can be hedged for short-term exposure with the use of forwards, futures or other derivatives. However, because of the short-term natures of these instruments, long-term exposure cannot be hedged easily.

2. On April 1, an Australian exporter sells A$10 million of coal to a New Zealand company. The importer is sent an invoice for NZ$11 million payable in 6 months. The spot exchange rate between the Australian and New Zealand dollars is NZ$1.1/A$.

a. If the spot exchange rate 6 months later is NZ$1.2/A$, what is the exchange rate gain/loss that will be made by the Australian exporter ?

b. How about if the spot exchange rate 6 months later is NZ$1.05/A$ ?

c. Discuss briefly the relative merits of using forwards to hedge foreign exchange risk.

a. If spot exchange rate 6 months later is NZ$1.2/A$, NZ$11 million in 6 months will be equivalent to A$9.17 million (11 million / 1.2), which means a loss of A$0.83 million.

b. If the spot exchange rate 6 months later is NZ$1.05/A$,...