NMIMS Global Access
School for Continuing Education (NGA-SCE)
Course: International Finance
Internal Assignment Applicable for Sept, 2018 Examination
As mentioned in the question, Raghu Steel Pvt Ltd is an Indian company which produces the products for domestic market only, even it courses the raw material from Indian Suppliers only.
In this case, there is no involvement of any transaction which is related to any foreign entity such as Importer, Foreign suppliers etc. so I do not think company faces any forex risk here. I will just explain about Forex threat here so it will be clear that company does not have to worry about it.
Foreign currency fluctuations happen across the world because the demand for and supply of
Different currencies are different in different countries at the same point of time. Foreign conversation risk – also called FX risk, coinage risk, or exchange rate risk – is the financial risk of an investment and the value changing due to the changes in currency exchange rates. This also refers to the risk an investor faces when he needs to close out a long or short position in a foreign currency at a loss, due to an adverse movement in exchange rates.
A firm involved in international occupational faces a higher degree of exposure to exchange rate fluctuations than a purely domestic firm. It is also difficult to assess the economic exposure of an
MNC as there is a complex interaction funds flowing into, out of and within an MNC. Economic exposure is very important for the operative of the firms in the long run. In case an MNC has subsidiaries around the world then the fluctuations in moneys will affect the subsidiaries. One method of measuring the financial contact of an MNC is through classification of cash flows
into different items on the income declaration and prediction of crusade of each item in the income statement that is based on a forecast of exchange rates. This will simplify the development of an alternative exchange rate scenario. It will also help in revising the forecasts of the income statement items. Dependent on the change in the forecasts for the economic statement items, it will become possible for the firm to assess the influence of currency movements on cash flows and earnings.
The economic exposure is further divided into transaction exposure and real operating exposure.
Transaction exposure refers to the foreign exchange loss or gain on communications already entered into and denominated in a foreign currency, as a result of changes in the exchange rate. In other words, transaction introduction is troubled with the vagaries in the present cash flows. Real operating exposure, on the other hand, is related to vagaries in future cash flows. It is anxious with the impact of exchange rate changes along with the vagaries in rise rate on the cost and revenue assembly of a firm.
It is clear that company has no connection to any foreign entity so no risk of any foreign exchange transaction. If the company enters any transaction with foreign entity then there is a
risk of foreign exchange but it can be narrowing. Managing or mitigating forex risks various financial instruments are used by companies in India and abroad in order to hedge the exchange risk. Such kinds of devices are available to the corporation at varying costs. The various tackles that hedge the different kinds of risks are given below:
? Forward contracts: A forward contract is a non-standardized contract that takes place between two parties for the purpose of selling or buying an asset at a specified future time at a price that has already been agreed. The party who buys the original position assumes a long position and the party who sells the asset shoulders a short position. Delivery price is the price that has been agreed upon. It is one of the most mutual means of hedging transactions in foreign currencies. It offers the ability to the users to lock in a sale price or a acquisitions without the involvement of any direct cost. It is also used by speculators who use forward contracts so as to place bets on the price movements of the underlying asset. Banks and many multinational establishments also use it to hedge the price risk by the elimination of uncertainty about prices.
? Futures contracts: It is a standardized contract that takes place between two parties for buying and selling a specified asset of standardized quality and quantity for a price that has been agreed at the present date. The payment and delivery takes place at a future quantified date which is also known as the delivery date.
? Option contracts: In this type of contract, the buyer of the option has the right but not the requirement to fulfill the transaction while the seller has the responsibility of pleasing the conditions stated in the indenture through the call option or a put option. The option conveying the right to buy the underlying asset at a specific price is called a call and the option conveying the right to sell the fundamental asset at a specific price is known as the put option.
? Currency Swap: The agreement that takes place between two parties through which they exchange a series of cash flows in one coinage for a series of cash flows in another currency is known as currency swap. It takes place at agreed breaks and over an decided period of time. Law doesn’t require it to be shown on a company’s balance sheet as it is measured to be a foreign exchange transaction.
As Mansukh Pickle Wala Pvt Ltd. is one of the largest exporters of Pickles in Europe and lag time of six months. As they get the payment later, there is always a currency risk while settling these transactions. To handle this risk better, Forward contract is a good choice. In the forward market, contracts are made to buy and sell currencies for future delivery, say, after a fortnight, one month two months, or three months. The rate of exchange for the contract is agreed upon on the very day the deal is finalized. The forward rates with varying adulthood are quoted in the journalists and those rates form the basis of the contract. Both the parties have to abide by the discussion rate stated in the bond irrespective of whether the spot rate on the maturity date is more or less than that of the forward rate. In other words, no party can back out of the deal, even if variations in the upcoming spot rate are not in his or her favor.
The value date in case of a forward contract lies definitely yonder the value date applicable to a spot contract. If it is a one-month forward contract, the value date will be the date in the next month agreeing to the spot value date. Suppose a coinage is purchased on 1 August, if it is a spot transaction, the coinage will be delivered on 3 August. But if it is a one-month forward contract, the value date will fall on 3 September. If the value date falls on a holiday, the later date will be the value date. If the value date does not exist in the calendar, such as 29 February (if it is not a leap year) the value date will reduction on 28 February. Sometimes, the price date is structured to enable one of the parties to the transaction to have the freedom to select a value date within the prescribed period. This happens when the party does not know in advance the precise date on which it would be able to deliver the exchange; for instance, an exporter who sells a foreign exchange forward without knowing in advance the precise date of delivery. Again, the maturity period of forward contract is normally for one month, two months, three months, and so on but sometimes it may not be for the whole month and a fraction of a month may also be involved. A forward contract with a maturity period of thirty-five days is an opposite example. Naturally, in this case, the value date falls on a date between two complete months. Such a contract is known as broken-date contract.
Arbitrage in forward markets It is said that the forward rate difference is roughly equal to the interest rate differential.
Sometimes, there may be marked deviation between these two differences. In such cases,
Covered curiosity arbitrage begins and lingers till the two differentials become equal. This is an arbitrage in advancing markets. Forward markets hedging Forward arcades are used not only by the arbitrageurs or speculators but by the hedgers too. Changes in the exchange rates are a usual phenomenon. Such changes entail some foreign exchange risk in terms of loss or gain to the traders and other participants in the foreign exchange market. Risk is reduced or hedged through onward markets transactions. Under the process of hedging, currencies are bought and sold forward. Onward buying and selling depends upon whether the hedger finds himself in a long, or a short position. An export billed in foreign currency creates a long location for the exporter. On the contrary, an import billed in foreign currency leads to a short position for the importer.
Forward foreign exchange contracts are useful for companies that have entered into a contract to either make or receive a foreign coinage payment at a fixed point in the future. In either case, it will eliminate the transaction exposure that is one of the three core components of foreign exchange risk. It makes the rate certain, and typically allows the company to know just what the proceeds will be or, in the case of a purchase, what the cost will be. There is, however, a residual economic exposure.
The uses of a forward foreign exchange contract vary slightly depending on whether the company is an importer or an exporter.
For the importer
An importer will have entered into a contract to import goods. The importer will need to pay for these goods with foreign currency on a pre-determined date in the future. Entering into a forward foreign exchange contract will allow the importer to know what the cost of these goods are in domestic currency at the point of agreeing to purchase them. This will allow the company to establish the cost of these goods with certainty.
For the Exporter
An exporter will be expecting a foreign currency payment on a specific date in the future. Entering into a forward foreign exchange contract will allow the exporter to know what the value of this future flow is either prior to, or shortly after, the contract to export is signed. Crucially, it allows the exporter to ensure that, although the price is set in a dissimilar currency, the company does know how much of its own currency it will receive and does not make a loss on the transaction after the foreign exchange transaction.
In both cases, forward foreign exchange contracts allow the company to eliminate the uncertainty associated with the future foreign exchange transaction. Such a business is particularly useful for companies that cannot hedge this exposure naturally, or that have to buy or sell at prices quoted in foreign currency. Some goods are traded in standard currencies (for example, oil is traded in dollars). In other businesses, a dominant customer may require its suppliers to invoice in its operating currency and thus assume any consequent foreign exchange risk.
Solution 3 (a)
The Trump administration has imposed 25 per cent tariffs on Chinese imports worth of up to $60 billion across high-tech sectors, citing high trade imbalance and IP rights infringement. The fine print is not yet public, but the move is expected to impact more than 1,300 products. A month-long consultation, post the published tariffs, would contemplate exemptions for respective industries. In a counter slap, China is considering give-and-take tariffs on $3 billion US imports.
International trade accounts for the major part of the international business. Certain other forms of international business, like international asset, may also be affected by international trade. The trading environment affects not only the exports and imports but also other factors such as international investment and financial flows. The main objectives of imposing trade barriers are to protect domestic businesses from foreign competition, to promote original research and development, to conserve the foreign exchange resources of the country, to make the balance of payments position favorable, to curb conspicuous consumption, to mobilize revenue for the government and to discriminate against certain countries. The most common barriers to trade are tariffs, quotas, and nontariff barriers. A tariff is a tax on imports, which is collected by the federal management and which raises the price of the good to the consumer. Also known as duties or import duties, tariffs usually aim first to limit imports and second to raise revenue.
A quota is a limit on the amount of a certain type of good that may be smuggled into the country.
A quota can be either voluntary or legally enforced. The effect of tariffs and quotas is the same: to limit imports and protect domestic producers from foreign competition. A tariff raises the price of the foreign good beyond the market evenness price, which decreases the demand for and, eventually, the supply of the foreign goods. A quota limits the supply to a certain quantity, which raises the price beyond the market equilibrium level and thus decreases demand.
Non-tariff barriers (NTBs), some of which are described as new protection measures (as against tariffs which are watched as traditional barriers), have grown considerably, particularly since around the beginning of the 1980s. The export growth of many developing countries has been seriously affected by the NTBs. The NTBs are of two categories. The first category includes those which are generally used by developing countries to prevent foreign exchange outflows or result from their chosen strategy of monetary development. These are mostly outdated NTBs such as import licensing, import quotas, foreign exchange regulations and canalization (means establishment of state monopoly in foreign trade). The second category of NTBs are those which are mostly used by developed economies to protect domestic industries which have lost international attractiveness and/or which are politically sensitive for governments of these countries.
Solution 3 (b)
A trade war with China could prove self-defeating, and Trump knows that. Across the-board tariffs on all Chinese imports are unlikely, given the economic consequences for the US. Although China loses more from the employment war given the huge trade extra it runs, there is barely any substitute yet for certain goods the US imports from China.
Trade barriers come in many forms. Quota is one. This is when a country sets a limit to the imported foodstuffs. This is done for a number of reasons. One is because the government of the importing country wants to protect its domestic producers. Other barriers or limits are added costs such as tariffs, duties, and taxes. In this way, trade barriers can affect international trade by revenging the flow of goods from producers to consumers. Where quotas, tariffs, and duties prevent this flow, it influences the productivity of the creators, although these will usually seek other markets without these barriers.
According to the World Bank, industrial countries are less sensitive to manufactured imports and consequently, maintain low tariff levels on manufactured goods. However, due to their high understanding to agricultural imports, higher pricelist stages are applied on agricultural goods. In fact, the average tariff protection on agricultural goods is nine times higher than on mass-produced goods. On average, emergent countries’ applied tariffs on industrial products are three to four times as high as those of industrial countries’. But their tariff levels on agricultural products are even higher.
Without net exports, a country cannot remain a consumer of other countries’ goods without incurring large debts through the imbalance of trade. It is usually economically beneficial to all revelries to maximize the production of their industries, through open markets to a wide consumer base. Countries in order to protect their parsimonies apply approaches of boundaries such as tariffs, quotas, subventions and argument controls. By applying isolationism a country can gain from it in such as protecting infant industries, dumping and protecting engineering industries, but on the other hand can also have problems such as firms remaining inefficient, retaliation, and misallocation of resources, and linked directly to universal trade kingdoms benefit on comparative and absolute plus, and economies of scales it affects the international trade. International trade increases the number of goods that domestic consumers can choose from, cuts the cost of those goods through increased competition, and allows domestic industries to ship their products abroad. While all of these seem beneficial, free trade isn’t widely accepted as completely beneficial to all parties. This article will examine why this is the case, and how Republics react to the diversity of factors that attempt to inspiration trade.