This presentation describes the theories & applications of foreign currency management.

1. Foreign Currency
Management

2. Exchange Rate
This is the rate at which the currency of one
country would change hands with currency of
another country.
E.g. $1 = SLR 130
Types of Exchange Rate
1. Floating Rate
This rate depends on a levels of the
international trade of a country and it does
not interfere with the government of that
country.

3. 2. Fixed Rate
This is the rate that the government of the
country would set its own currency rate and it
is not depending on the market rate.
3. Dirty Float
This is the rate that mixed between floating
rate and fixed rate system. This is where the
government would allow exchange rate to
float between a particular two limits. If it goes
outside either of the limit, then the
government would take further action.

4. Forex Dealings
1. Bid Price
The price at which the currency is bought
by the dealer.
2. Offer Price
The price at which the currency is sold by
the dealer.
 When regarding the forex dealings,
Offer Price > Bid Price

5. Example 01:
David is a UK businessman. He needs $ 400,000
to buy US equipment.
Identify the amount of £ required to buy the
Dollars? ($/£ 1.75 - 1.77)
Answer:
The amount of £ required = $ 400,000
$/£ 1.75
= £ 228571.43

6. Example 02:
James is a US businessman. He has just received
a payment of £ 150,000 from his main customer
in UK.
Identify the amount of $ received by James
when £ 150,000 are given? (£/$ 0.61 – 0.63)
Answer:
The amount of $ received = £ 150,000
£/$ 0.63
= $ 238095.24

7. Spot Rate and Forward Rate
Spot Rate
This is the rate which is applicable for the
immediate delivery of currency as at now.
Forward Rate
This is a rate that set for the future
transaction for a fixed amount of currency.
The transaction would take place on the
future date at this agreed rate by disregarding
the market rate.

8. Discounts & Premiums
Discounts
If the forward rate which is quoted cheaper,
then it is set to be quoted at a discount.
E.g. $/£ current spot is 1.8500-1.8800 and the
one month forward rate at 0.0008-0.0012 at a
discount.
Answer:
1.8500-1.8800
+ 0.0008-0.0012
= 1.8508-1.8812
When quoted at a discount,
their should be more Dollars
being received at a given Pound.
So the discount factor have to
be added to the spot rate.

9. Premiums
If the forward rate which is quoted more
expensively, then it is set to be quoted at a
premium.
E.g. $/£ current spot is 1.9000-1.9300 and the
one month forward rate at 0.0010-0.0007 at a
premium.
Answer:
1.9000-1.9300
- 0.0010-0.0007
= 1.8990-1.9293
When quoted at a premium,
their should be less Dollars being
received at a given Pound because
of the expensiveness of Dollars. So
the premium factor have to be
deducted from the spot rate.

10. Foreign Exchange Rate Risks
1. Transaction Risk
This is the risk that adverse exchange rate
movement occurring in the cause of normal
international trading transaction. This arises
when the prices of imports or exports are
fixed in foreign currency terms and there is a
movement in the exchange rate between the
date when the price is agreed and when the
cash is paid or received.

11. 2. Translation Risk
This is the risk that the organization will
made exchange losses when the accounting
results of its foreign branches or subsidiaries
translated into the local currency.
3. Economic Risk
This is the risk that suppose to a effect of
exchange rate movements on the
international competitiveness of the
company.

12. 4. Direct & Indirect Currency Quotes
Direct Quote:
This means the exchange rate is mentioned in
terms of the amount of domestic currency
which needs to be given in returns for one unit
of foreign currency.
E.g. SLR 130 for $1
Indirect Quote:
This means the amount of foreign currency
units that needs to be given to obtain one unit
of domestic currency.
E.g. $ 1/130 for SLR 1

13. Example 01
ABC Ltd is a US company, buying goods from
Sri Lanka which cost SLR 200,000. These goods
are resold in the US for $2000 at the time of
the import purchased. The current spot rate is
$1 = SLR 126-130.
Calculate the expected profit of the resale in
terms of US Dollars using both direct & indirect
quote methods.

14. Answer:
1.) Under Direct Quote Method
$/SLR = 1/126 - 1/130
= 0.00794 – 0.00769
Sales = $2000
(-)Purchase Cost=SLR200,000*$/SLR0.00794 =($1588)
Expected Profit = $412
2.) Under Indirect Quote Method
Sales = $2000
(-)Purchase Cost=SLR200,000/SLR126/$ =($1587)
Expected Profit = $413

15. Managing the Exchange Rate Risk
1. Invoicing in domestic currency
Since the exporter does not have to do any
currency transaction in this method, the risk of
currency conversion is transferred to the
importer or vice versa.
2. Money Market Hedging
Because of the close relationship between
forward exchange rate and the interest rate in
two currencies, it is possible to calculate a
forward rate by using the spot exchange rate
and money market lending or borrowing which
is called as a money market hedge.

16. 3. Entering into Forward Exchange Rate Contracts
A person can enter into an agreement with a
bank to purchase the foreign currency on the
fixed date at a fixed rate.
4. Matching receipts & payments
Under this method a company can set off its
payments against its receipts in that particular
currency.
5. Options
These are similar to forward trade agreements,
but the consumer can choose between the
bank’s rate and the market rate.

17. Example 01
A Sri Lankan company has to settle $800,000
after three months time. The current spot rate is
$1 = SLR 126-130. The foreign currency depositing
interest rate is 12%per annum and the borrowing
rate in Sri Lanka is 8% per annum. The agreed
exchange rate with the bank is $1 = SLR128.
The company has identified to overcome the
exchange rate under Money Market Hedging &
Forward Exchange Rate Contract methods.
Identify the cheapest method to overcome the
exchange rate risk.

18. Answer:
1.) Using Money Market Hedging Method
FV = PV* (1+r)n r = 0.12*3/12
PV = $800,000* (1+ 0.03)-1 r = 0.03
PV = $776,699 n = 1
Purchase Cost(SLR) = $776,699*SLR130/$1
= SLR 100,970,870
Interest Cost(SLR) = SLR 100,970,870*0.08*3/12
= SLR 2,019,417
Total Cost(SLR) = SLR(100,970,870+2,019,417)
= SLR 102,990,287

19. 2.) Using Forward Exchange Rate Contract Method
Total Cost (SLR) = $ 800,000*SLR128/$1
= $102,400,000
The best method is forward Exchange Rate
Contract Method, because it gives the lowest total
cost when compare to Money Market Hedging
Method.

20. Reasons for Short Term Changes of Exchange Rate
1. Investment Flows
If a country does more investment to outside
countries, then there would be a higher
demand for foreign currency. Therefore the
domestic will depreciated or vice versa.
2. Trade Flows
In a given time if a country has more imports
and less exports, the domestic currency will
depreciated, because of the higher demand for
the foreign currency or vice versa.

21. 3. Economic Prospectus
If a country has good economic policies and
is showing shines of economic growth, it
could receive more investment and
therefore the domestic currency would
appreciated.

22. Reasons for Long Term Changes of Exchange Rate
1. Purchasing Power Parity Theory
This theory describes how the differences in
inflation rate among two countries would lead
to changes in the exchange rates.
Future Rate(A/B)=Spot Rate(A/B) * (1+ Inflation Rate of A)
(1 +Inflation Rate of B)
2. Interest Rate Parity Theory
This theory links the future currency rates with
differences in interest rate among two
countries.
Future Rate(A/B)=Spot Rate(A/B) * (1+ Interest Rate of A)
(1 +Interest Rate of B)

23. 3. Monetarist Theory
This theory identifies the relationship between
exchange rate and the government money
supply to an economy of one country.
E.g. When the government released more money
to their economy, individual would have more
money. So they would purchased more, the
demand will increased & through that result in
higher prices & high inflation.
This would lead to a high level of depreciation
to the currency.

24. 4. Keynesian Approach
This theory says that an exchange rate may not
change in a balance and sometimes currency
may continuously appreciate or depreciate
without reverse.
E.g. There is a high taste & demand for imported
product in one country while their exports are
losing its export position in other countries.
Therefore, without any appreciation of
currency will continuously depreciate over a
long time period in that country.