Answer As mentioned in the question, Raghu Steel Pvt Ltd is an Indian company which produces the products for domestic market only, even it processes 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 risk 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 exchange risk – also called FX risk, currency risk, or exchange rate risk – is the financial risk of an investments 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 business 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.
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Economic exposure is very important for the functioning of the firms in the long run. In case an MNC has subsidiaries around the world then the fluctuations in currencies will affect the subsidiaries. One method of measuring the economic exposure of an MNC is through classification of cash flows into different items on the income statement and prediction of movement of each item in the income statement that is based on a forecast of exchange rates. This will facilitate the development of an alternative exchange rate scenario.
It will also help in revising the forecasts of the income statement items. Depending 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 transactions already entered into and denominated in a foreign currency, as a result of changes in the exchange rate. In other words, transaction exposure is concerned with the changes in the present cash flows. Real operating exposure, on the other hand, is related to changes in future cash flows. It is concerned with the impact of exchange rate changes along with the changes in inflation rate on the cost and revenue structure of a firm.
Its 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 mitigated. 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 instruments are available to the company at varying costs. The various tools 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 underlying position assumes a long position and the party who sells the asset assumes a short position.
Delivery price is the price that has been agreed upon. It is one of the most common means of hedging transactions in foreign currencies. It offers the ability to the users to lock in a sale price or a purchase 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 corporations 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 specified 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 obligation to fulfill the transaction while the seller has the responsibility of fulfilling the conditions stated in the contract through the delivery of the shares to the appropriate party. An option can be distinguished as a 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 underlying 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 currency for a series of cash flows in another currency is known as currency swap.
It takes place at agreed intervals and over an agreed period of time. Law doesnt require it to be shown on a companys balance sheet as it is considered to be a foreign exchange transaction. 2. State Bank of India is the Official banker for Mansukh Pickle Wala Pvt. Ltd.
Which is one of the largest exporters of pickles in Europe. The company has a lag time of six months from the time it sells its product and collects the money from the retailers in Euros. In order to reduce its currency risk the company enters into an outright forward transaction with the bank.
How can State Bank of India mitigate its risk in the given case Answer 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 transaction is agreed upon on the very day the deal is finalized. The forward rates with varying maturity are quoted in the newspapers and those rates form the basis of the contract.
Both the parties have to abide by the exchange rate mentioned in the contract 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 changes in the future spot rate are not in his or her favour. The value date in case of a forward contract lies definitely beyond 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 corresponding to the spot value date. Suppose a currency is purchased on 1 August, if it is a spot transaction, the currency 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 subsequent 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 fall on 28 February. Sometimes, the value 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 currency for instance, an exporter who sells a foreign currency forward without knowing in advance the precise date of shipment. 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 differential is approximately equal to the interest rate differential. Sometimes, there may be marked deviation between these two differentials.
In such cases, covered interest arbitrage begins and continues till the two differentials become equal. This is an arbitrage in forward markets. Forward markets hedging Forward markets 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 forward markets transactions.
Under the process of hedging, currencies are bought and sold forward. Forward 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 position 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 currency 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 exactly 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 different 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 transaction 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 industries, a dominant customer may require its suppliers to invoice in its operating currency and thus assume any consequent foreign exchange risk. 3. Fears of a trade war heightened in March 2018 as the Trump administration slapped trade sanctions on China, including restrictions on investment and tariffs on 60bn worth of products. Fears of a trade war between the two biggest economies in the world were also reflected in the bond market, with US 10-year treasury bonds posting their biggest one-day drop in yields since September. Further, bank and tech stocks also fell.
a) What are the various trade barriers that companies can resort to under such situations b) What is the impact of such trade barriers on global trade in general and international financial markets in particular Answer 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 reciprocal 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 investment, 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 industries from foreign competition, to promote indigenous research and development, to conserve the foreign exchange resources of the country, to make the balance of payments position favourable, 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 government 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 imported 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 equilibrium 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 protectionism measures (as against tariffs which are regarded 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 economic development.
These are mostly traditional 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 competitiveness and/or which are politically sensitive for governments of these countries. 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 repercussions for the US. Although China loses more from the trade war given the huge trade surplus 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 products. This is done for a number of reasons. One is because the government of the importing country wants to protect its domestic manufacturers.
Other barriers or limitations are added costs such as tariffs, duties, and taxes. In this way, trade barriers can affect international trade by preventing the flow of goods from producers to consumers. Where quotas, tariffs, and duties prevent this flow, it impacts the productivity of the producers, 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 sensitivity to agricultural imports, higher tariff levels are applied on agricultural goods. In fact, the average tariff protection on agricultural goods is nine times higher than on manufactured goods. On average, developing 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 parties to maximize the production of their industries, through open markets to a wide consumer base. Countries in order to protect their economies apply methods of restrictions such as tariffs, quotas, subsidies and exchange controls. By applying protectionism a country can gain from it in such as protecting infant industries, dumping and protecting manufacturing industries, but on the other hand can also have problems such as firms remaining inefficient, retaliation, and misallocation of resources, and related directly to international trade countries benefit on comparative and absolute advantage, and economies of scales it affects the international trade. International trade increases the number of goods that domestic consumers can choose from, decreases 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 isnt widely accepted as completely beneficial to all parties. This article will examine why this is the case, and how countries react to the variety of factors that attempt to influence trade. Y, dXiJ(x(I_TS1EZBmU/xYy5g/GMGeD3Vqq8K)fw9xrxwrTZaGy8IjbRcXIu3KGnD1NIBsRuKV.ELM2fiVvlu8zH(W )6-rCSj id DAIqbJx6kASht(QpmcaSlXP1Mh9MVdDAaVBfJP8AVf 6Q
