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0/20
Chapter 3
Foreign Exchange Control and
Management
1/20
Foreign exchange concepts
Types and factors of exchange rates
Government influence on exchange
rate
Aims and Methods of Exchange control
Managing Foreign exchange risk
Translation, Transaction, and Economic
Exposures
Currency futures and options
Chapter contents
International Public financial management
2/20
Forex is the value of one unit of
currency in terms of another currency
markets where currencies of different
countries are traded
spot rate and forward rate
3.1 Foreign exchange concepts
International Public financial management
3/20
Participants
Retail customers-includes businesses,
international investors, multinational
corporations and the like who need foreign
exchange for the purposes of operating their
businesses.
Commercial banks - the commercial banks
carry out buy/sell orders from their retail
clients and buy/sell currencies on their own
account so as to alter the structure of their
assets and liabilities in different currencies.
3.1 Foreign exchange concepts
International Public financial management
4/20
Participants
 Foreign exchange brokers - often
banks do not trade directly with one
another, rather they offer to buy and
sell currencies via foreign exchange
brokers.
 Central banks  buy/sell foreign
currencies to influence its value
3.1 Foreign exchange concepts
International Public financial management
5/20
Foreign exchange regimes
 Fixed exchange rate system- is where
a value of a currency in terms of other
currencies is fixed.
 Floating exchange rate system  is
where value of a currency is
determined by the force of demand
and supply.
3.1 Foreign exchange concepts
International Public financial management
6/20
Foreign exchange regimes
 Pegged exchange rate system- value
of a given currency is attached to
another currency
 Managed floating exchange rate
system-currency is floated but
interventions are made when there
are significant fluctuations.
3.1 Foreign exchange concepts
International Public financial management
7/20
the determinants include:
 relative inflation rates
 relative interest rates
 relative income levels
 government controls
 expectations
3.2 Determinants of forex rate
International Public financial management
8/20
1) Direct intervention
by exchanging foreign currency with
local currency
can be sterilized or non-sterilized
intervention
3.3 Government influence on exchange
rate
International Public financial management
9/20
Sterilized intervention
 the government buys or sells local
currency(in the forex market) to
manipulate the exchange rate and at
the same time undertakes an
offseting transaction in the money
market to keep money supply
unaffected
3.3 Government influence on exchange
rate
International Public financial management
10/20
Non-sterilized intervention
 the the government buys or sells
local currency to manipulate its value
 no offseting transaction is
undertaken in the money market to
keep money supply unaffected
3.3 Government influence on exchange
rate
International Public financial management
11/20
2) indirect intervention
adjustment of interest rate-
increase interest rate to discourage
outflow of funds
using foreign exchange controls-
restriction on the exchange of the
currency
3.3 Government influence on exchange
rate
International Public financial management
12/20
Effects of stronger local currency
Lower inflation
Higher unemployment
3.3 Government influence on exchange
rate
International Public financial management
13/20
Effects of weaker local currency
Higher inflation
Low unemployment
3.3 Government influence on exchange
rate
International Public financial management
14/20
Price stability
Lower unemployment
3.4Aims of exchange rate control
International Public financial management
15/20
Types of exposure
1. Transaction exposure
2. Economic exposure
3. Translation exposure
3.5 Measuring exposure to exchange
rate
International Public financial management
16/20
Transaction exposure- is the
sensitivity of the firms contractual
transactions in foreign currencies to
exchange rate movements
Economic exposure-sensitivity of the
firms cash flows to exchange rate
movements.
Eg. Impact of a stronger ETB on export
earnings.
3.5 Measuring exposure to exchange
rate
International Public financial management
17/20
Translation exposure-exposure of the
MNCs consolidated financial
statements to exchange rate
fluctuations.
3.5 Measuring exposure to exchange
rate
International Public financial management
18/20
Transaction exposure
Futures hedge-for small transactions
Forward hedge-for large transactions
Money market hedge
Currency option hedge
 Economic exposure
 through restructuring - shifting sources of
costs and revenues to other locations to
match cash inflows and outflows in foreign
currencies
3.6 Managing foreign exchange
exposure
International Public financial management
19/20
Currency forward contract
agreement between buyer and seller to
trade currencies at a specific rate on a
specific date
Currency future contract
similar to forward contract, except that
it is traded in an organized exchange
indeminity is available in case of default
3.6 Managing foreign exchange
exposure
International Public financial management
20/20
Options are contracts that allow, but do not
require, one or both parties to obtain certain
benefits under certain conditions.
Currency options provide the right to
purchase or sell currencies at specified
prices.
3.6 Managing foreign exchange
exposure
International Public financial management
21/20
End of chapter 3

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IPFM Ch03.pptx

  • 1. 0/20 Chapter 3 Foreign Exchange Control and Management
  • 2. 1/20 Foreign exchange concepts Types and factors of exchange rates Government influence on exchange rate Aims and Methods of Exchange control Managing Foreign exchange risk Translation, Transaction, and Economic Exposures Currency futures and options Chapter contents International Public financial management
  • 3. 2/20 Forex is the value of one unit of currency in terms of another currency markets where currencies of different countries are traded spot rate and forward rate 3.1 Foreign exchange concepts International Public financial management
  • 4. 3/20 Participants Retail customers-includes businesses, international investors, multinational corporations and the like who need foreign exchange for the purposes of operating their businesses. Commercial banks - the commercial banks carry out buy/sell orders from their retail clients and buy/sell currencies on their own account so as to alter the structure of their assets and liabilities in different currencies. 3.1 Foreign exchange concepts International Public financial management
  • 5. 4/20 Participants Foreign exchange brokers - often banks do not trade directly with one another, rather they offer to buy and sell currencies via foreign exchange brokers. Central banks buy/sell foreign currencies to influence its value 3.1 Foreign exchange concepts International Public financial management
  • 6. 5/20 Foreign exchange regimes Fixed exchange rate system- is where a value of a currency in terms of other currencies is fixed. Floating exchange rate system is where value of a currency is determined by the force of demand and supply. 3.1 Foreign exchange concepts International Public financial management
  • 7. 6/20 Foreign exchange regimes Pegged exchange rate system- value of a given currency is attached to another currency Managed floating exchange rate system-currency is floated but interventions are made when there are significant fluctuations. 3.1 Foreign exchange concepts International Public financial management
  • 8. 7/20 the determinants include: relative inflation rates relative interest rates relative income levels government controls expectations 3.2 Determinants of forex rate International Public financial management
  • 9. 8/20 1) Direct intervention by exchanging foreign currency with local currency can be sterilized or non-sterilized intervention 3.3 Government influence on exchange rate International Public financial management
  • 10. 9/20 Sterilized intervention the government buys or sells local currency(in the forex market) to manipulate the exchange rate and at the same time undertakes an offseting transaction in the money market to keep money supply unaffected 3.3 Government influence on exchange rate International Public financial management
  • 11. 10/20 Non-sterilized intervention the the government buys or sells local currency to manipulate its value no offseting transaction is undertaken in the money market to keep money supply unaffected 3.3 Government influence on exchange rate International Public financial management
  • 12. 11/20 2) indirect intervention adjustment of interest rate- increase interest rate to discourage outflow of funds using foreign exchange controls- restriction on the exchange of the currency 3.3 Government influence on exchange rate International Public financial management
  • 13. 12/20 Effects of stronger local currency Lower inflation Higher unemployment 3.3 Government influence on exchange rate International Public financial management
  • 14. 13/20 Effects of weaker local currency Higher inflation Low unemployment 3.3 Government influence on exchange rate International Public financial management
  • 15. 14/20 Price stability Lower unemployment 3.4Aims of exchange rate control International Public financial management
  • 16. 15/20 Types of exposure 1. Transaction exposure 2. Economic exposure 3. Translation exposure 3.5 Measuring exposure to exchange rate International Public financial management
  • 17. 16/20 Transaction exposure- is the sensitivity of the firms contractual transactions in foreign currencies to exchange rate movements Economic exposure-sensitivity of the firms cash flows to exchange rate movements. Eg. Impact of a stronger ETB on export earnings. 3.5 Measuring exposure to exchange rate International Public financial management
  • 18. 17/20 Translation exposure-exposure of the MNCs consolidated financial statements to exchange rate fluctuations. 3.5 Measuring exposure to exchange rate International Public financial management
  • 19. 18/20 Transaction exposure Futures hedge-for small transactions Forward hedge-for large transactions Money market hedge Currency option hedge Economic exposure through restructuring - shifting sources of costs and revenues to other locations to match cash inflows and outflows in foreign currencies 3.6 Managing foreign exchange exposure International Public financial management
  • 20. 19/20 Currency forward contract agreement between buyer and seller to trade currencies at a specific rate on a specific date Currency future contract similar to forward contract, except that it is traded in an organized exchange indeminity is available in case of default 3.6 Managing foreign exchange exposure International Public financial management
  • 21. 20/20 Options are contracts that allow, but do not require, one or both parties to obtain certain benefits under certain conditions. Currency options provide the right to purchase or sell currencies at specified prices. 3.6 Managing foreign exchange exposure International Public financial management