Purpose Of Foreign Exchange Risk Hedge Finance Essay - Free Essay Example

This report has been produced as a request of the course International Financial Management. This report has been developed in three segments. Part one explaining the factors related to hedging and the alternative techniques available. It also brings into consideration the factor that the CEOs request of the techniques have also been brought under and compared. Part two has compared all three selected options and has produced the final selection. Last part has a comparison of the forward and option derivatives. Part (a) Explain the purpose of hedging foreign exchange risk and describe the alternative hedging techniques available, particularly the processes involved for each of the three hedging approaches preferred by the CEO and referred to above. Foreign exchange risk comes in when companies start dealing across boundaries and they find dealing in foreign exchange. The common dealing that happens among companies Is when taking receivables and giving payables. Following transactions always takes place in foreign and home currency and the rate involved is the risky factor. The risk involved in the factor is that before the transaction has happened the exchange rate might fluctuate and change in such a scenari o the company might end up losing money  [1]  . The difference paid between two countries currency is called foreign exchange risk. The currency of one country when sees a fall there will always be a gain in another countries currency value, this depreciation and appreciation between currency values can occur drops in value. Depreciation takes place when purchasing of another currency requires more of the home currency. Appreciation is just the opposite; the currency is able to purchase more units of the other countrys currency. Nearly all currencies are valued according to the rate in the market so the exchange rates keeps on fluctuates. This risk is the exchange risk and hedging is one solution to cover it up. There are many ways to reduce this risk but the two popular approaches used very commonly are called hedging and netting. Hedging is when u buy a forward contract in a date in the future this is done to cover the liabilities occurring in the future. Forward exchang e contracts are often used to cover the risk of foreign exchange fluctuations. Apart from hedging another popular technique very commonly used is called netting. Netting is used to maintain equal levels of foreign exchange as compared to equal levels of payables. This would help you to net out the effect and the difference between the two hence the result would be zero and the company would not incur any loss. Using this technique the buyer and the seller both can be at advantage, if the buyer nets at a good rate than he would be able to earn more and same goes for the seller he can also earn a lot. This technique helps both the buyer and the seller. There are many other ways of dealing with hedging which can be options, futures forwards. Further in this answer I will elaborate each one of them one by one. The only differences between each of them are the related requirements and the costs associated with each one of them. The cost of one can be very high as compared to anothe r one at a certain time period and vice versa. If a company is having foreign exchange risk than they would certainly want to compare a number of techniques and see whether which one of them is profitable and which one is not. Purpose of Foreign Exchange Risk Hedge In normal words speaking the purpose of any hedging technique is to help the investor protect against any such events in the future that will cause him/her to lose their investment. When it comes to currency then thee simple idea is to simply either convert or exchange the currency to cover the risk. While keeping in mind the exchange rate one would want to hedge and save themselves by changing into another currency that would provide them cover. For example, instead of trying to pay for shares of a companys stocks which is in the UK but is paying in US dollars, the investor will look to first make a conversion into Pounds and then later see to make it into the united states dollars, once the conversions are done only than purchases can be made. To further protect themselves the investors might also look up selling the purchased shares on a particular date. Alternative Techniques 1. Futures A future contract is a standardized, transferable, exchange traded contract that requires delivery of a commodity, bond, currency, or stock index at a specified price, on a specified future date. Generally the delivery does not occur instead before the contract expires the holder usually square their position by paying or receiving the difference between the current market price of an underlying asset and the price stipulated in the contract. Specifications of a future contract The future contract itself tells why it is being used to sell and purchase, it also defines the way in which the contract would take place. A future contract would define it as: It will tell a fixed amount of commodity or any other thing that is being traded. (e.g, 5,00 bags of rice, 100 Euros, dollars etc.) It would also define the quality of the commodity being traded (this might not be true for all sort of commodities thus needs to be adjusted accordingly; currencies if used in the transaction do not have various levels quality and thus stay plain as they are). The rules for price adjustments would also be defined be the future contract for commodities and price would be adjusted accordingly to quality which can be of a specified rating. The minimum amount of fluctuations that the contract can bear would also be mentioned. The contract would also define the day of delivery and the way the possession would be taken would be defined too. The contract would furthe r define the per unit price. Finally the number of days i.e. the hours and the time would also be explained about how much time would be taken for the exchange to happen. 2. Currency Swaps  [2] A currency swap is something in which two investors exchange a particular amount of currency for another one for a particular time period and this amount is used agreed between two parties. Once the agreement gets over both the parties give back the original sum that was exchanged between both of them. To take care of legislations for currencies all over the world the currency swap is an efficient and useful technique. A currency swap can have a maturity up to 30 years maximum. According to international accounting standards the currency swap would not be considered as a loan hence if it is not a loan than it would not ever appear on the liabilities or any other part of the balance sheet. Rather it appears as a foreign exchange transaction with a forward contract so that it can be closed. All the funds involved in the transaction are paid  [3]  . It is not a very common transaction that happens instead companies use it to service debts as well. This technique can also be used to get better cash flows in which one company borrows at a lower cost in one currency and then exchanges it for a debt to another company which really desires to get some. In this way both the companies can earn easily and improve their cash flows  [4]  . Advantages The main advantage of getting into a currency swap is that you can keep negotiating it for a longer period of time rather as compared to a normal swap. Entering the swap can help the parties to fight against factors such as fluctuation of both interest rates and currencies. Even a better access to the local market can be gained via doing so. When companies tend to do so in currency swaps they can easily cope up with their currency rate risk and exchange rate risk too. The extra benefit gained from doing currency swaps is that they can help reduce the   counterparty risk, whihch comes from bid and ask price. By default it can be said to combine with interest rate risks and currency swaps can help avoid them. The terms can also set up asking either a fix or a floating rate thus the flexibility of the terms can also help to focus. Disadvantages The benefits are good but the disadvantage is the cost that is involved in such transactions and along with them the settlement and the un settlement risks involved in it. The biggest risk involved in doing a currency swaps is that the other party might fill up their obligation and in this case the main party might end up losing money, yes legal actions can be taken but in some cases they remain in vain  [5]  . The other disadvantage is that one of the party might want to quit the transaction before time, the party that remains should have an approval of the other party and thus can decide upon which exit strategy needs to be taken, same is the case when it comes to futures and forwards that the exit strategy must be pre decided between both the parties. Following can be some ways of taking an exit: Entering into an offsetting swap Selling the swap to a  third party Purchasing a swaption. 3. Options An option is a contract but not an obligation and the holder of the option might or might not use it on the date of the option, the price of the use is already predetermined. An option can be either a put option or a call option. A put option will allow the holder to sell a particular security on the date of maturity for a desired price, while the call option will allow the holder to buy it. It is also defined in some places as a promise by the issuer to the holder to fulfill a particular price on a particular date, the risk is that the price can be higher or lower on the desired date. It also protects the offeere from the offer to revoke it . Still careful consideration is required as still it is a type of contract. Typically, an offeree can provide consideration for the option contract by paying money for the contract or by providing value in some other form such as by rendering other performance or  forbearance  [6]  . CEOs Requested Techniques 1. Forwards Forwards are rather similar contracts between two parties in which they decide on a particular asset to be sold on a price on a future date.  This is similar to a spot in contrast, sots asks to sell the asset on date today but forwards decide a date in the future. The costs for a forward contract is nothing. The party looking to buy the asset would be looking at a longer termed position, while the seller will see a shorter termed position. The price agreed upon is called the  delivery price, which is equal to the  forward price  at the time the contract is entered into  [7]  . 2. Money Market Hedge Money market hedges refers to things where techniques are used to lock in particular rates related to foreign exchange and cash equivalents. Even after having the design to hedge against risk they have a particular set of risk involved with them. Some of the shortfalls of a money market hedge are complexity and disclosure which are further elaborated below: Complexity Hedging strategies are mostly misunderstood due to their complexity levels apart from the market insiders common people do mix them. The commonly used money market hedges are futures, forwards, options, swaps etc  [8]  . Furthermore the complexity adds on when the people involved and responsible for financial engineering keep on rolling out new ways of hedging making the entire process more and more complex. The second most common issue is the selection of the appropriate hedge for an appropriate situation making things difficult. Disclosure Disclosure has always been an issue with derivatives. The disclosure issues more because of the rapid pace at which they are traded all over the place. If the investors trust shakes in a particular institution they tend to liquidate very rapidly this can cause a market or a institution to shake. This is one main reason that the impact remains unknown. 3. Billing in US Dollars First of all this is not a hedging technique. This is just a billing technique where by a company invoices its clients in US dollars by using the current spot rates. The spot rate in our case is mentioned in the data which is 15.3555 as we have shown in our calculations in the next part. Part (b) Show your calculations of the expected proceeds in dollars after six months using each of the three chosen hedging approaches respectively and indicate which of them you would recommend and explain why. Calculation of Expected proceeds in US$ The expected proceeds from each of the 3 methods are calculated as Billing in US$ The company will use the rate 15.3555 (Peso/USD) to bill the other party in US dollars. The expected proceeds will be calculated as follows: Expected proceeds in US $ in six months=500M /15.3555= $ 32.56162287M Six Month Forward Rate Contract If the company engage in 6 month forward rate contract then the expected proceeds will be calculated as: Expected proceeds in US $ in six months= 500M/15.0134= $33.30358213M (Using Forward Rate Contract) Money Market Hedge If the company is interested in money market hedge the expected proceeds will calculated using these steps: The company first borrow peso @ 1.3% (for 6 month borrowing rate in Mexico) which is [500M/(1.013)]= 493.5834156M Peso The company will convert US dollars @ 15.3561 exchange rate which will result into 493.5834156M/15.3561= $ 32.14249813M Now deposit $32.14249813M in US bank @ (1.55% for 6 months) which will result into $32.14249813M *1.0155= $ 32.64070685. After a year the company will receive its 500M peso and will adjust its loan of 500m peso with the Mexican bank. Recommendation My recommendation is the six month forward rate contract as this is the one which is more appropriate than any others. This gives maximum returns to its investors and covers their six months return. Part (c) Critically assess the features which distinguish forward exchange fixed contracts and forward exchange option contracts. To distinguish forward exchange contracts from option contracts we will critically analyse both forward exchange fixed and forward contracts. Forward Exchange Fixed Contract A forward exchange contract is a contract to conduct a transaction at a fixed rate of exchange on either a fixed future date or during a fixed period of time. Forward exchange contracts help to manage the risk of foreign currency denominated payables or receivables. By entering in to a forward exchange contract, we are benefiting of locking in the rate of currency exchange to mitigate the risk inherent in a future payments obligation. Some of the advantages and disadvantages of forward contracts will be highlighted to understand its characteristics. Advantages Some of the advantages of forward contracts are as: Protection against unfavourable exchange rate fluctuations. The exact values of the import and export orders can be calculated on the day it is processed. Budgeting and costing are accurate. It can be written for any amount and term. Offers a complete edge. They cater for a diverse type of commercial and financial transactions and both importers and exporters can make use of it. Disadvantages Company cannot take advantage of preferential exchange rate movements once entered into forward exchange fixed contracts. If an order is cancelled or there is any surplus amount outstanding on a forward exchange, it must be surrendered at the prevailing spot exchange rate, which can result in a financial loss. Early deliveries, extensions, surrenders and cancellations during the fixed period of a forward exchange contract are done on a swap basis causing additional administration Difficult to find a counterpart (No liquidity) Requires typing up capital Subject to default risk. Forward Exchange Option Contracts A forward exchange option contract is different from forward fixed contract as in option contract the buyer of the option has the right but not the obligation to buy or sell a specified currency or stock at a specified exchange rate, at a specified date from the seller of the option. There are two types of options, one is called Call Option and the one is called Put Option. Call Option- It gives the right to buy a specified currency or stock at a specified exchange rate at specified date. Put Option- It gives the buyer the right to sell a specific currency or stock at a specified exchange rate at a specified price. Advantages The main advantage of forward exchange option is flexibility. Secondly in options there is neither initial margin nor daily variation margin as the position is not market to market. Due to it many companies enjoys significant cash flow relief. Disadvantages Some of the disadvantages of options are Written for fixed amount and terms Subject to basis risk Offers only partial hedge

The Issue Of Age Legalization - 971 Words

At the age of 18, people are allowed to join armed forces for the service of the nation. They are able to risk their lives for the nation and its betterment. After joining the military, they travel to many places and countries where they have to do the service. They are able to make such decisions by themselves. In addition to that, the country has made cigarettes and tobacco legal for people aged older than 18. It is found that the effects of smoking cigarettes and drinking alcoholic beverages have similar kind of problems in body. Taking both in unmannered amount causes Emphysema, lung cancer, erectile dysfunction, high blood pressure and many other problems without seeing any age group. Yet, it is also found that taking one or two alcoholic beverages day can actually be beneficial to the body. So it does not matter about age legalization, rather it depends on the amount of consumption while concerning about the health of the people. 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Essay America Needs the War in Iraq - 755 Words

America Needs the War in Iraq It has been three years since the war in Iraq started. In the US, people are afraid of some attacks, which may come in the future from terrorist groups. The US wants to control Iraq completely this time. Everyday, wherever I go, the news about war catches my ears and eyes. It is on the radio, on the net, and on television programs in the US. It means that everybody in this country really is concerned about the situation in Iraq because of American soldiers who fight in Iraq and people in Iraq. Through some news on television, Iraq is chaos now. Luckily, the US troops are superior. Wounded people are mostly terrorists because the weapons of the coalition troops are more advanced. Even†¦show more content†¦According to Lynn J, Cook, how oil affects the US economy is, â€Å"Every 10% drop in prices of oil adds 0.1% to the US economy, and the sooner the Iraqis start pumping, the faster the plunge in per-barrel prices. 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The Mbuti Pygmies free essay sample

For the tribe the ituri forest is everything; they view the forest as a scared place in the world, since there is an ample amount of food all year long. There unique traditional economy is run on the basis of survival and not surplus. The mbuti only take what they need and feel that working to gain more than what you need is pointless. That’s why when deciding what to produce, the mbuti tribes or bands always search for the essentials of living, along with scared items for ceremonies or rituals. The mbuti people like live in small bands and that band decides what they need. They also distribute the goods according to who needs it. The people are very social among the tribe, they like to work together and spend time with family and friends when there not searching or hunting for goods. The ituri forest has an ample amount of supply throughout the year; it contains many mushrooms, roots, berries, nuts and herbs and a variety of leafy vegetables. We will write a custom essay sample on The Mbuti Pygmies or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page The forest is also a provider of medicines. The mbuti use the forest to treat many different kinds of illnesses including headaches, eye inflammation, heart pains, toothaches, pen wounds, toe rot and even hemorrhoids. All of which are treated by natural substances that contain leaves, tree bark, stems, plants, roots and berries. The mbuti people try to make use of all the things the forest has to provide. The mbuti tribe divides up the work based on gender; both males and females have specific roles to play in their survival. The mbuti live in huts that are mainly made by the women of the tribe. Each hut holds one family if factors remain constant such as weather conditions. The huts are made out of tree stems as the base structure and then covered with bark and long leaves as a protection from wind, sun, heat, rain and dirt. Women are responsible for the building of the huts, however before the construction occurs everyone helps gather the materials needed. Hunting and gathering of game is mainly done by the men of the tribe. While sometimes females also gather berries and materials. The mbuti men and women both wear a loincloth made out of bark that is softened and hammered until it is long and smooth. Women have a longer loincloth, theirs hang down close to the ground; where men just have the cloth covering their genitals; making it more effective to wonder throughout the forest in search for game. They wear their clothes not for protection but for socialistic reasons. The Mbuti people are very spiritual and have many rituals where they thank the forest and everything it has provided them with. There are many items produced that are significant when having special occasions and reciting rituals. Black paste made from burnt ashes and fat from distinct animals are smeared on the body. The black paste is a significant ritual that is supposed to bring the person physically and psychologically closer to the forest. An important ceremonial event occurs after a good hunt where charms made out of tree vines and wood are placed on the body of the hunters. The mbuti also cover their arms with bracelets that are made from animal teeth, feathers, animal skin and wood. Ceremonies and rituals are also a way for the mbuti people to socialize and to spend time together. Items produced that have no need for survival or spiritual rituals and ceremonies are used for leisure activities. Spin tops, mainly used by the children, are made out of nut sections of the shell which is spun on the ground. Gambling exists in the mbuti cultural as well, though primarily played by the adults, children sometimes play. Seeds are dried out and thrown on the ground to make a total number that is a multiple of four. Those who have a multiple of four win the game and take the remainder of the seeds. Tug-of-war is another popular game that incorporates the whole band. The rope is made out of vines from trees where a group of people are on either sides of the vine and pull it in their direction. Such games were played to pass time, have fun and to strengthen bonds between the members of the groups. The pygmy people rely on hunting- gathering for sustenance and collection of food. They employ essentially four different methods of hunting namely, hunting in groups with spears for large mammals, hunting alone with bows and poison tipped arrows for monkeys, and hunting in groups with bows and iron tipped arrows for duikers and other mid-sized mammals. The animals they eat include crabs, shellfish, ants, larvae, snails, pigs, antelopes, monkeys, fishes, and honey. The vegetable component of their diet includes wild yams, berries, fruits, roots, leaves, and cola nuts. Mbuti’s are very small in height only averaging about four feet and are very thin and stocky. Since their hunting techniques are not technological advanced they have adapted to make themselves invisible in the forest. Mbuti men although short have the ability to kill an elephant with only short-handed spear. Hunting tools that are produced include spears, and bow and arrows; all of which are crafted by hand with help of fire (fire makes the spears and bows sharp when heated and hammered down). There are also nets made out of tree stems and bark to help hunters capture animals. Although many hunters roam throughout the forest with no weapons they believe that they belong to the forest so there is no need for fear, the only danger is what lies outside the forest Hunting for monkeys is a solitary activity the success of which depends upon the stealth of the hunter. The hunter would travel quietly listening and looking out for monkeys feeding on the tress. He attempts to anticipate the direction of the troop movement and positions himself accordingly, usually under a fruit bearing tree. The hunter then attempts to shoot the monkeys as they approach using his poison tipped arrow. The great majority of the arrows are lost as they lose their targets i. e the monkey. The hunter then goes to fetch the monkey that has been hit and takes it back to his own clan. Net hunting is used mainly for the collection and hunting of antelopes. These nets are generally produced by women and owned by married men or outstanding hunters. The mbutis hunting technique is to rig nets, about 1 meter high and up to 100 m long, end-to-end in a semicircle, reaching 1500 m in perimeter, then to drive all the game inside toward the nets. Small game, such as Gambian rats, porcupines and mongoose often escape by slipping underneath the net or through its 7-centimeter mesh. Large game, animals weighing over 30 kilograms, can break through. Thus the net hunt is especially adapted to the capture of duikers, small antelope. The animal is then captured and killed used suitable tools. The hunting methods the Mbuti people use is regarded as efficient and effective since none of the resources or animals gathered are being wasted; this is because the Mbuti people do not hunt more than what they need except when they use the excess hunt for trade with other villagers. Also, given the circumstances, the Mbuti people normally hunt in bands in order to increase their catch or to succeed in hunting larger preys such as elephants. No or very little resources and human resources are wasted in the process of hunting; gathering too since it’s an easy task which is done by an individual only who gathers fruits and sometimes honey for the nuclear family of his. In the mbuti there is no such thing as surplus, for a variety of reasons. The surplus is valued very highly in many cultures although mbuti’s do not feel the need to take more than what is needed for survival yet if there are some items that are left over they are used for ceremonies such as the charms. The mbuti live unmaterialistic lives in the sense that physical possessions are not valued. Since the mbuti’s are foragers it is impossible to move around with a surplus supply of goods. Since there is no fear that there will ever be a shortage of game and vegetation in the forest there is no need to create surplus; even though, the mbuti’s have the capability to create and to do so. The mbuti feel as if creating a surplus of goods is a waste of time. If they have everything required for survival, there is no need to search for more. They would rather spend their time with other members of the tribe celebrating life and honoring the forest for providing them with everything. Economic aspects of the reciprocity between Mbuti and villagers have been maintained for a long time. Starch foods from villagers gardens make up a significant part of Mbuti diet year-round. Mbuti provide villagers, on an irregular basis, with prestige foods such as meat and honey from the forest. They help clear and harvest the gardens and participate in seasonal fishing expeditions. Mbuti also provide diverse forest products such as thatching and construction materials, firewood, medicinal plants and edible mushrooms. Exchange relations between Mbuti and villagers are not rigidly defined; there are no fixed terms of trade. Cash is rarely involved and exchanges may even take the form of gift giving. Mbuti, as nomads, are highly unpredictable in what they will provide and when they will provide it. Villagers, on the other hand, have a fairly predictable yearly cycle of activities centered on the preparation, planting and harvesting of their gardens. women who are most often involved in initiating, negotiating and terminating trade relationships with the village, and it is primarily the village women with whom exchanges are executed. A large proportion of exchanges a woman makes are with the wife of her husbands traditional trading partner. Exchanges of meat and honey in particular are usually made with this person. These tributes of prestige foods are probably crucial in maintaining the stability of long-term ties. However, women establish many other trading relationships on their own initiative. Although the prospect of acquiring meat or honey in the future is probably an important factor in the willingness of the village to enter new associations with the mbuti, it is most often the labor of women rather than forest products which villagers receive in exchange for food and material goods. Tasks which women perform for villagers include agricultural work, maintenance tasks such as collecting wood and water, and collection of forest products used in building and maintaining village houses. Cultivated foods procured by mbuti women in exchange for labor form the mainstay of the diet, and women retain control over the distribution of all foods they procure. Men also provide labor for villagers, particularly when patches of forest are being cleared for gardens. A man may also on occasion take meat directly to his village patron, rather than allowing his wife to make the exchange. Men, however, request payment in non-food items such as implements, clothing, tobacco and marijuana much more often than women. Trading relationships established by women can become very important during times of food shortage, when villagers may be unwilling or unable to continue providing food for their traditional mbuti trading partners. An household or even the entire band may then initiate a formal relationship with another village or villager, frequently ones with whom the women in the group have already established informal ties. A group may also temporarily join another band that is associated with a wealthier village. This joining of bands is often the result of kin ties of women in the group. The mbuti women have considerable freedom in their choice of subsistence strategies. They decide how much time to spend gathering or working in the village. They may work alone, or cooperate with other women in procuring food. They also have considerable influence over group decisions, particularly those regarding the location of camps. Since women routinely carry up to three-quarters of their body weight in food from the village, camps which are located long distances from the village represent much greater work effort than those which are close. In contrast, mens preferred hunting sites are usually very far from the village. It is rare for an mbuti camp to be located more than a days walk from the village; most are within a four-hour walk. Although never totally out of touch with villagers, Mbuti spend a great deal of time in the forest. They are considered by all, including themselves, as the forest people, being the most familiar with the forest and the most efficient at extracting its resources. There is no monetary value on the exchange for items that is needed for the mbuti efficiency. Since the forest doesn’t provide them with any sort of metal they exchange goods such as game and vegetation with villagers for iron blades and metal pots. This is the only time when they create a surplus of goods. Exchanging food for metal items is Pareto efficient. Since the mbuti have an abundant supply of natural resources this is considered a very fair trade because in return they are receiving goods that will make daily tasks much easier. Although there is no need for metal items in the mbuti cultural, the metal acts as an efficient way to make food and kill game by having pots and blades for their spears and bows. Trade amongst the band rarely happens and the need to have fair reciprocity is rare. Kinship is amongst everyone in the tribe even if there is no blood relationship. The mbuti tribes have set up different rules regarding, what to produce, how to produce and how to distribute. Everything produced in the mbuti society has a significant role; whether it is for survival, spiritual ceremonies or simply for leisure activities. They hunt and gather their food, along with rare visits to the surrounding villages. Also the goods are divided on the basis of who needs what. They are a very social tribe and care for one another even they have no blood relationships. One cannot simply compare the mbuti society to any modernized or westernized society because what is important to one is not important to the other. Westernized societies are mainly self-interested desiring profit and surplus where the mbuti society are mainly focused on living and socialization amongst the society; each having different motives. From looking through the view point of the mbuti, one can answer that question by stating what they are producing is effective in meeting the needs are fulfilled. However, looking through the view point of the modernized society one would answer that question by stating that the production of goods are not meeting the needs for the society because what is being produced is only fulfilling survival and spiritual needs. They are not utilizing their full capability to produce goods furthermore there is significant opportunity costs. Although, the mbuti could convey that there society is economically efficient as they are getting the highest benefit from the economies resources. Both societies have different wants and needs that shape the way they live and perceive life.