An international organization is obviously obliged to carry out transactions using foreign currency. Whenever settlements are made in foreign currency, transaction exposures cannot be eluded. When products denominated in foreign currency are sold or bought on credit terms, transaction exposures can easily arise. As a measure to minimize transaction exposure on this ground, transactions carried out in debts should be avoided as much as possible.
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It is vital to mention that an organization should mainly deal with cash transactions instead of accumulating huge uncleared debts in foreign currency (Arcelus, Gor & Srinivasan, 2013). However, domestic transactions that cannot be affected by changes in foreign exchange rates can be carried out before payments are fully cleared so long as they do not lead to bad debts. Importers and exports of goods and services should be wary of fluctuations in exchange rates. Hence, this calls for the adoption of effective protection measures. It is possible to lose thousands of dollars owing to a slight or marginal change in foreign exchange rates. Therefore, businesses should assess the foreign exchange market just before making purchasing or selling decisions in the international market. Business organizations can employ the services of foreign currency experts so that they can be in a position to project when a rise or fall in foreign currency is likely to take place. This approach can significantly reduce transaction exposure (Smith, 2014).
Debt repayments made in foreign currency as well as obtaining assets that are either being sold or bought using foreign currency can all lead to transaction exposures. If debts must be paid in foreign currency, then it is highly advisable for a corporation to make such repayments when the exchange rate is favorable. For instance, debt repayment can be made when the local currency is stable compared to foreign currencies. An organization can also decide to make such repayments once or in a few number of times as part and parcel of minimizing transaction exposure. In the case of selling or buying property using foreign currency, a firm can avoid or reduce transaction exposure by including foreign exchange fluctuations in the final selling price of the product. Hence, the selling price can be set slightly higher in order to cover such unpredictable changes. On the other hand, organizations should bargain for the lowest possible market price for goods bought foreign currency so that any unfavorable deviation in the exchange rate can be factored favorably into the buying price.
Since there are various types of exposures that a firm operating in a global platform can encounter, it is crucial for the affected firms to begin by minimizing the actual transaction exposures.
Riggit forward can be sold by a US corporation. This strategy is possible due to the aspect of applying a forward contract. To begin with, it is crucial to negotiate with the concerned financial institution so that a more viable way of exchanging the dollars can be established. In doing so, a specific exchange rate must be agreed upon between the corporation and the bank or financial institution. The identified exchange rate that the two parties have agreed upon is known as the forward rate. Hence, the same rate can be used as a sealing agreement between the concerned organization and financial institution at a later date.
Any amount of foreign currency can be bought at the current date and sold in the future. In this case, a US corporation can purchase a forward contract and subsequently release the same into the market due to receivables (Smith, 2014). This technique assists a business organization to manage a number of transaction exposures that are encountered in the course of doing business. Although an organization in the United States may decide to hedge net receivables using a number of operating tactics such as risk sharing, exposure netting, initiating price adjustment clauses, and risk shifting, it is still highly advisable for corporations to employ contractual hedges. This can be combined with financial hedges such as the use of swaps. The future market hedge, options market hedge, money market hedge, and forward market hedge can indeed compliment Riggit forwarding explained above. For example, an American aerospace company might be contemplating on the best strategy to employ in hedging the sale of tickets worth 100 sterling pounds which is expected to fall under receivables in the next 200 days. On the same note, the available exchange rates are listed below:
- United States dollars 200-day interest rate (per year) 7.01%-6.98%
- Sterling pounds 200-day interest rate (per year) 5.01%-4.97%
- 200-day forward rate $0.7639-99/Sterling Pound
- Spot rate $0.7643-42/Sterling Pound
The above is a critical illustration of how a US corporation can go about the forward hedging strategy.
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If the approach is not applicable in the corporation, then there are a number of available techniques that can still be employed. For example, the corporation can use the money market to carry out the hedging process (Dumitrescu, 2009). In addition, forward marketing hedging is still a viable option for a corporation located in the United States. Better still, the corporation may opt to remain unhedged.
Arcelus, F. J., Gor, R., & Srinivasan, G. (2013). Foreign exchange transaction exposure in a newsvendor setting. European Journal of Operational Research, 227(3), 552-554.
Dumitrescu, D. (2009). Managing Transaction Exposure. Annales Universitatis Apulensis : Series Oeconomica, 11(1), 359-367.
Smith, R. M. (2014). Corporates revise hedging strategies, survey reveals. FX Week, 25(26), 3-10.