Exchange Transactions

Any financial transaction that involves more than one currency is foreign exchange transaction. The exchange rate is the rate at which we can exchange one currency for another. It is a crucial determinant of the trade in goods and assets. An increase in the value of a currency is called appreciation, and a reduction in value is called depreciation.

Exchange Exposure

Borrower of a low interest rate in foreign currency may suffer from depreciation of home currency. Investor in Foreign currency bonds benefits from weakening of home currency. Exporter suffers from reduction in value of converted export proceeds because of rise in value of home currency

Exchange Exposure

Inward / Outward Remittances Import Payments Export Receipts Foreign Investments (to/from) FCY Borrowing / Lending Buying and selling currencies against other currencies

Exchange Exposure
Transaction
Exchange Rate
Inward Remittances Outward Remittances Import Commitments Exports Reciepts Investment Abroad Foreign Investment Borrowing in Foreign Currency Lending in Foreign Currency Long Currency Position Short Currency Position Squar Currency Position Loss Profit Profit Loss Loss Loss Profit Loss Loss Profit NIL Profit Loss Loss Profit Profit Profit Loss Profit Profit Loss NIL Currency Appreciation Currency Depriciation Transaction Amount Transaction Value 80.00 100,000,000 $ 1,250,000.00 Value if Apprciates 79.00 98,750,000.00 Value if Depriciates 81.00 101,250,000.00

(100,000,000) $ (1,250,000.00) (98,750,000.00) (101,250,000.00) (100,000,000) $ (1,250,000.00) (98,750,000.00) (101,250,000.00) 100,000,000 $ 1,250,000.00 100,000,000 $ 1,250,000.00 100,000,000 $ 1,250,000.00 98,750,000.00 98,750,000.00 98,750,000.00 101,250,000.00 101,250,000.00 101,250,000.00

(100,000,000) $ (1,250,000.00) (98,750,000.00) (101,250,000.00) 100,000,000 $ 1,250,000.00 100,000,000 $ 1,250,000.00 98,750,000.00 98,750,000.00 101,250,000.00 101,250,000.00

(100,000,000) $ (1,250,000.00) (98,750,000.00) (101,250,000.00) -

Foreign Exchange Risk

Exposure to exchange rate movement Any sale or purchase of foreign currency entails foreign exchange risk. Foreign exchange transaction affects the net asset or net liability position of the buyer/seller. Carrying net assets or net liability position in any currency gives rise to exchange risk.

Foreign Exchange Risk

Transaction Risk : Exposure to exchange rate

movements arising out of Trade and Trading.

Translation Risk : Foreign branches and subsidiaries

are translated into home currency.

Economic Risk : Effect of exchange rate movements on

international competitiveness of company.

Components of FX transaction

Base Currency (PKR in a USD/PKR deal) Dealt Currency (USD in a USD/PKR deal) Exchange Rate Amount Deal Date Value Date (Ready, Tom, Spot) Split value transactions

Exchange Rates - Mathematics

Direct / Indirect quotes : Direct quote is the amount of

domestic currency equal to Foreign currency unit vice versa.

Reference versus Base Currency : If a currency is

quoted at GBP/PKR 120.00, the PKR is the reference currency and GBP is base currency.

Exchange Rates - Mathematics

Thumb Rule:

Market gives you less and takes more from you Facing and Quoting Rates Bid and Offer A confusion ? Every Foreign Currency Transaction comes back to Local Currency

Interpretation of FX Quotation
USD/JPY 117.10 117.20 Means that market will give you 117.10 yen for ever one USD and will take 117.20 yen to give you one USD EUR/USD Bid 1.2100 Offer 1.2110

The customer can buy EUR 1 by giving USD 1.2110 The customer can sell EUR 1 to take USD 1.2100

Cross Rate Calculation

USD/PKR USD/JPY 59.80 114.80 60.20 115.40

USD/PKR
USD/JPY

59.80
114.80

60.20
115.40

JPY/PKR
Contd..

0.518

0.524

Playing with Quotes : Practice

You are facing these quotes from Reuters Currency Bid Offer USD/PKR 60.00 60.05 EUR/USD 1.2100 1.2110 GBP/USD 1.7400 1.7410 USD/JPY 117.00 117.10
Quote your customer if he wishes to BUY EURO 100,000 = USD ? Sell GBP 250,000 = USD ? Buy USD 350,000 = EURO ? Sell JPY 100,000,000 = PKR ?

1.2110 1.7400 1.2100 0.5124