Foreign Financial Management Assessment Answer

1. Discuss and explain the functions of the foreign exchange market.

2. Discuss spot exchange rates and its overall importance in the market.

3. What is forward exchange rate and what role do they play in insuring against foreign exchange risk?

4. Discuss at least one theory explaining how currency exchange rates are determined and their relative merits.

5. Discuss and evaluate the merits of different approaches toward exchange rate forecasting.

6. Discuss the differences between translation, transaction and economic exposure and what managers can do to manager each type of exposure.

<h1id="Analysis_of_International_Currency_Exchange_Rates_in_India" style="text-align: center;">Analysis of International Rates in India

Function of Foreign Exchange market in India:

-- rate is currently prevailing in the market. In this market the rate of exchange of Rupees is determined by the market forces. When the Indian Economy booms the rate goes up and vice versa. In such market the external factors which are not in control of India plays a huge role in determining the exchange rate of Indian rupees (Fernandes, 2015). The trading segment is not very complicated in India and it works almost similar to how the general trading is done. There is a need to open a FOREX account, to maintain the accountability of the market. The more intelligently, the FOREX is managed, manages the worth of Indian Rupee in the international market. This further adds impact on the other exports and imports related activities and whatever profits that can be gained from these business functions depends on that (Chakrabarti, 2015). The rate of exchange is determinant of the fact that what will be inflation level since the imported products will face a price rise as well.

Spot Exchange Rate and its overall impact:

The Spot Exchange return is the rate existing in the open market, which accounts for the value of the currency for immediate settlement of exchange. It is also famously known as the benchmark rates or straight forward rates since the settlement has to be done immediately and the future impacts may be positive or negative for the transaction (Hayes, 2015). The transaction of such nature is done, if there is an anticipation of price increase in the near future and a good rate is available at a spot rate and hence the traders go ahead and take that risk. The impact has seldom worked in favor of Indian Rupee, as the transactions in the international markets increases and there is a surge in the overall price as well. But that may not be the only source of truth as sometimes the forces are strong enough to absorb the surge in exchanges and even then the rates are seen to be deteriorating and the currency value lowers (Fama, 1984).

Forward Exchange Rate and its role in Foreign Exchange Risk:

This is an extension of the spot rates of exchange, since here the base is considered to be the Spot rate of Exchange and then there is a carrying cost that is added to it. It can be any time of transaction return, like settling of the product payments that were taken by the supplier from the vendor, or could be as simple as settling of the loan payment which has floating rates of returns. In both the scenarios, the main concern is the risk that comes along with it. The management of forward exchange rate needs a very thorough management knowledge of funds. There are various types of risks linked with Foreign Exchange Rates, like transaction risk, which is related to the risk of cash flow. It can sometimes be translation risk, which the fluctuation which may be observed when there is a unconditional fluctuation seen in the overall exchange system (Papaioannou, 2010). There are various other types of risks which are discussed in the upcoming sections but there have been instances where the system does not fall in place and there is a catastrophic failure of firms’ altogether.

How are Currency Exchange Rates Determined?

There are many factors that plays a pivotal role in determining the Foreign exchange rate, the focus however here is kept on a developing economy with major focus on agriculture like India. The factors that plays a pivotal role in that case are Inflation, Interest Rates, Current Account Deficits and Public Debt. There are tons of other options as well, but these are of prime focus and interest as far as this report is concerned. All these factors plays a vital role in defining the stature and strength of an economy and in case these factors are not in favor of the country, then the currency will surely dip. Consider the case of India, the factors like Public Debt and Current Account deficits are not in favor and hence the currency exchange rates keep on weakening and that has the impact on the import and export of the economy overall. These are main factors that are identified and they have good amount of impact on the exchange rate of the economy (Bergen, 2009).

Merits of Approaches towards Exchange Rate Forecasting:

Currency Exchange Rate forecast is a very tricky affair and hence need a lot of introspection and assessment of not just internal forces or external forces, but the well coordination established between them as well. If any of the aspect goes missing there is no way the correct forecast can be met or established. The main aspect that is considered at least in a country like India is the Purchase Power Parity, as it has a direct indication towards the purchasing and buying power of the people and that will improve the trade deficit as well. Hence the impact anticipated on the exchange rate is good as well. The economic strength and wellness is the second major impact that is seen to have an impression over the correctness of the forecasting as well. The strength of the economy is the determinant of the power of its products and the head they held high while negotiation and that overall has a huge impact on the exchange rates over all (Nguyen, 2013).

Translation, Transaction and Economic Exposure:

Transaction Exposure is something that has a very small life span, medium to small range ideally and it is an exposure or obligation that forces the company or an installation to serve to the payments in the future currency mode. Since the anticipated risk is high and hence the tenure is small. For an Indian manger, they must avoid such situations as one is never sure how the currency is going to behave and what attribute will have what detrimental effect.
Translational exposures are the effects visible on the company’s financial statements and that is due to the company’s presence in other geographies. Like Indian IT companies suffered from a major blow when the dollar rate devalued, as their major chunk was coming from there only. Now, in such scenario a manager must ensure to keep a mix bag of options and should not depend on a single country subsidiary totally (Kramer, 2014).
The Economic exposure is the most dreadful of all considering Indian context, since mainly it is long term in nature and secondly it is directly dependent on the unexpected currency fluctuations. These issues are common in Indian economy and hence the manager must ensure to maintain a cap over the currency accumulation and also there must be no major delays in settlement of the old accounts as well.

References

1. Bergen, J. V. (2009). 6 Factors That Influence Exchange Rates. Mumbai: Investopedia.
2. Chakrabarti, R. (2015). Foreign Exchange Markets . Hyderabad: The Indian School of Business.
3. Fama, E. F. (1984). Forward and Spot Exchange Rates. Chicago: Journal of Monetary Economicws.
4. Fernandes, S. (2015). Forex Trading In India: How It Works and What You Need To Know? New Delhi: Good Returs Publications.
5. Hayes, M. (2015). Spot Exchange Rate. London: Investopedia.
6. Kramer, C. (2014). Types of Foreign Exchange (Currency) Exposure. London: EFinancemanagement Journal.
7. Nguyen, J. (2013). 4 Ways To Forecast Currency Changes. Chennai: Investopedia Publications.
8. Papaioannou, M. (2010). Exchange Rate Risk Measurement and Management: Issues and Approaches for Firms . Geneva: IMF.