Foreign Exchange fluctuations Risk

If the export bills are drawn in rupees, the exporter is not affected by the fluctuations in exchange rates. But generally the buyer prefers to be invoiced in his own currency as this enables him not know how much the goods will cost him in his own currency. Agreeing for invoice in buyer currency involves not merely a courtesy on the buyer but also a good marketing strategy. If the bills are drawn in foreign currencies the exporter will have to bear the exchange fluctuations risks. If the currency in which the bill is denominated depreciates in terms of rupees he will receive less in rupees and there is a possibility that the entire profit contemplated on exports might be wiped off. But if the currency appreciates the exporter will stand to gain. However, if the bills are purchased by a banker the loss or profit is borne by the banker and the exporter is absolved of the risks. But if the bills are accepted by a banker for collection, the loss / profit belongs to the exporter.

Factors Determining Exchange rates:

It will be useful for the exporter to know the various factors that influence the exchanges rates. By a study of these factors and the trend of movements in the value of a particular currency, an experienced businessman may be able to forecast the possible future movement of that currency This will enable him to determine whether it would be worthwhile for him to carry the risk.

Primary determinants: (1) Demand and supply of a particular currency are the most important factors affecting its exchange rate. In general, if a country has an import surplus, its exchange rate is likely to depreciate; in case of export surplus, the rate is likely to go up. There are three classes of transactions on the foreign exchange market; purchases and sales for trading purposes speculative deals by professional dealers and protective movements by substantial holders. Professional dealers are willing to buy or sell currencies according to their estimate of that the future exchange rate is likely to be from those who want to sell or buy to hedge their position or eliminate the speculative elements in their transactions. There are protective movements of funds by multinational corporations to avoid losses. (2) Domestic economic policies affecting the internal purchasing power of the currency concerned or, in other words, the relative inflation rates also affect the exchange rates. A country with a higher rate of inflation than other countries may witness a decline in the value of its currency relative to other currencies and vice versa.

Secondary determinants: (1) Expectation and other psychological factors have considerable influence on the exchange rate. Flight of hot money or short term capital movement provides an obvious example. (2) So, also international differentials in interest rates have specially important effect on the exchange rate (3) Political events such as a change in government have dramatic impact on the exchange rate of a currency even before any change in government policies takes place. This occurs on the assumption that changes will be made because of previous experience with the particular party, or because of certain stated intentions in the election manifestoes (4) If the instruments about the future exchange rates is predominantly bearish, it will have its impact on the spot exchange rate as well, leading to depreciation. If the sentiment about the future exchange rate is bullish, the spot rate is likely to go up.

Arbitrage operations involving simultaneous purchase and sale of foreign currencies in different markets lead to equalization of exchange rates in different markets.

The management of foreign exchange fluctuations risks would, therefore involve the following steps:

(1) Quantify the risk and its timings; (2) undertake a risk assessment of the likely fluctuations of foreign currencies envisaged; (3) operate under a clearly defined policy (4) continuously study and analyze the local foreign exchange market; (5) obtain forward cover at optimal points, and (6) evaluate /monitor actual performance.