Overseas Trade

Question 1

What’s a pro and a con with invoicing in home currency?

Answer 1

+Transfers risk to the other party.

-May not be commercial acceptable.

Question 2

What is “Transaction Risk”?

Answer 2

The risk that the FX rate will change between the date of contract and the date of settlement.

Question 3

What is “Economic Risk”?

Answer 3

The risk that the the value of the business will be affected by long run changes in exchange rates.

Question 4

What “Translation Risk”?

Answer 4

The risk that reported performance will be affected by exchange rate movements.

Question 5

What are 4 ways you can manage transaction risk?

Answer 5

• Invoice in sterling.
• Leading and lagging.
• Matching.
• Foreign currency bank accounts.

Question 6

Will banks sell the base currency high or low?

Answer 6

Low.

Question 7

Will banks buy the base currency high or low?

Answer 7

High.

Question 8

Is the base currency USD or GBP for 1.4325 - 1.4330?

Answer 8

GBP

Question 9

Is the variable currency USD or GBP for 1.4325 - 1.4330?

Answer 9

USD

Question 10

Explain “Leading”.

Answer 10

If an exporter expects that the currency it is due to receive will depreciate over the next few months it may try to obtain payment immediately (could offer a discount).

Question 11

Explain “Lagging”.

Answer 11

If an importer expects that the currency it is due to pay will depreciate over the next few months it may try to delay payment (could exceed credit terms).

Question 12

Is “Leading and Lagging” a form of hedging?

Answer 12

No, it is speculation.

Question 13

Explain “Matching”.

Answer 13

When a company has receipts and payments int same foreign currency it can simply match them against each other and then deal with only the unmatched part.

Question 14

Explain how having a foreign currency bank account works?

Answer 14

When a firm has regular receipts and payments in the same currency it may choose to operate a foreign currency bank account. This acts as a permanent matching process and limits exposure to the net balance on the account.

Question 15

What are forward rates?

Answer 15

A discount or a premium on the spot rate.

Question 16

What do you do with a discounted forward rate?

Answer 16

Add. Get more $ per £.

Question 17

What do you do with a forward rate at a premium?

Answer 17

Subtract. Get less $ per £.

Question 18

How do you hedge a payment? (Money Market Hedge)

Answer 18

Buy the PV of foreign currency amount today at the spot rate. Place it on deposit to accrue interest until the transaction date and then use it to make the FX payment.

Question 19

How do you hedge a receipt?(Money market)

Answer 19

Borrow the present value of the foreign currency amount today then sell it at spot for GBP. Results in immediate and certain receipt of the GBP which can be invested. The loan accrues interest until the transaction date. The loan is repaid in full with the foreign currency receipt.

Question 20

Forward Rate/Expected future rate=

Answer 20

Average Spot Rate x (1+Average OS interest/inflation rate)/(1+Average UK interest/inflation rate)

Question 21

What are the 4 main risks that increase when trading overseas?

Answer 21

• Physical risk.
• Trade Risk.
• Liquidity risk.
• Credit risk.

Question 22

What is a physical risk?

Answer 22

The risk of goods being lost in transit.

Question 23

What is trade risk?

Answer 23

The risk of an order being cancelled/delivery refused.

Question 24

What is liquidity risk?

Answer 24

The inability to finance a longer operating cycle.

Question 25

What is credit risk?

Answer 25

Increased bad debts.

Question 26

What are 4 ways you can reduce credit risk?

Answer 26

- Using bills of exchange. - Documentary credit. - Export factoring. - Export insurance.

Question 27

What are the 4 steps to deal with any futures question?

Answer 27

1) Decide whether to buy or sell. 2) Decide what expiry date to pick. 3) Calculate the number of contracts. 4) Show the calculation (two elements)

Question 28

What are the 5 steps to deal with any traded options question?

Answer 28

1) Decide whether to buy a call or a put. 2) Decide what expiry date to pick (the next date AFTER you expect to act) 3) Calculate the number of contracts. 4) Decide what strike price to choose. 5) Show the calculation (three elements).

Question 29

How do you calculate the average spot rate for estimating the discount/premium on a currency?

Answer 29

Add both current spot rates then divide by 2.

Question 30

How do you calculate the average OS interest rate for estimating the discount/premium on a currency?

Answer 30

Add both current OS interest rates then divide by 2.

Question 31

How do you calculate the average UK interest rate for estimating the discount/premium on a currency?

Answer 31

Add both current UK interest rates then divide by 2.

Question 32

How do you calculate the estimated premium?

Answer 32

Average calculated forward rate - Average current spot rate.

Question 33

What should you always remember when calculating the expected future rate?

Answer 33

Pro-rate the average interest rates used. e.g. if you're calculating the expected rate in 4 months you need to 4/12 the annual interest rates.

Question 34

5 ways you can mitigate economic exposure. (no hedging)

Answer 34

1. Diversify operations world-wide both for purchasing raw materials and selling its products. 2. Market and promotional management; the company must carefully decide in which markets to operate. 3. Product management; economic exposure may mean high-risk product decisions. 4. Pricing strategy must respond to the risk of fluctuations in exchange rates. 5. Production management; economic exposure may influence the supply and location of production.

Question 35

What 4 things should be considered | when considering investing overseas?

Answer 35

``` CAMP Cultural risk - difference in behaviors Advantages we already have - Do we have experience in that market? Market attractiveness - GDP and forecast demand in that region Political risk - import quotas/tariffs, legal restrictions, restriction on foreign ownership, protectionism ```