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GLOBAL ACCOUNTING AND CONTROL: A MANAGERIAL EMPHASIS. Sidney J. Gray , University of New South Wales Stephen B. Salter , University of Cincinnati Lee H. Radebaugh , Brigham Young University. CHAPTER TWO. FOREIGN CURRENCIES AND EXCHANGE RISK MANAGEMENT.

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GLOBAL ACCOUNTING AND CONTROL: A MANAGERIAL EMPHASIS

  • Sidney J. Gray, University of New South Wales

  • Stephen B. Salter, University of Cincinnati

  • Lee H. Radebaugh, Brigham Young University

Gray, Salter & Radebaugh Chapter 2


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CHAPTER TWO

FOREIGN CURRENCIES AND EXCHANGE RISK MANAGEMENT

Gray, Salter & Radebaugh Chapter 2


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FOREIGN EXCHANGE RISKS AND SOLUTIONSImporting for Cash Problem

  • Let’s explain with an example.

  • Your firm, Alamo Computers of San Antonio, Texas, USA, wishes to buy some computer motherboards.

  • Here are three suppliers with prices in their local currency.

Gray, Salter & Radebaugh Chapter 2


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FX RISKS & SOLUTIONS CONT’DImporting Goods for Cash Problem

Gray, Salter & Radebaugh Chapter 2


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FX RISKS & SOLUTIONS CONT’DImporting Goods for Cash Problem

  • What do we do now?

    • Calculate the price in a common currency (US$ would be logical since you are US based company).

  • How do we do that?

    • Get the price in local currency (LCP) for each location from the table.

    • Divide the LCP by the LC/US$ exchange rate or multiply the LCP by the US$/LC exchange rate toget theUS$ Price.

    • See Tables 2.1 or www.oanda.com.

Gray, Salter & Radebaugh Chapter 2


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Table 2.1US Dollar Exchange Rates in Number of Foreign Currency Units Per $ - Thursday October 7, 1999

Gray, Salter & Radebaugh Chapter 2


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FX RISKS & SOLUTIONS CONT’DImporting Goods for Cash

Gray, Salter & Radebaugh Chapter 2


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FX RISKS & SOLUTIONS CONT’DImporting Goods for Cash

Gray, Salter & Radebaugh Chapter 2


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FX RISKS AND SOLUTIONSImporting Goods for Credit

  • What if you want to buy on credit?

  • Will the exchange rate stay the same?

  • Is Singapore still the cheapest supplier?

Gray, Salter & Radebaugh Chapter 2


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Vendors allow you to pay in two-months

however, the Singapore $ and British Pound are floating currencies.

FX RISKS AND SOLUTIONSImporting Goods for Credit

Gray, Salter & Radebaugh Chapter 2


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The British Pound Floats

Gray, Salter & Radebaugh Chapter 2


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The Singapore $ Floats

Gray, Salter & Radebaugh Chapter 2


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Table 2.3Cost of Motherboards Using Credit

Paying FC Two-Months After Purchase on September 28, 2005

Gray, Salter & Radebaugh Chapter 2


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Table 2.3Cost of Motherboards Using Credit

Paying FC Two-Months After Purchase on September 28, 2005

Gray, Salter & Radebaugh Chapter 2


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FX RISKS AND SOLUTIONSImporting Goods for Credit

  • Can you protect yourself from fluctuations in the exchange rate?

  • You can neutralize the risk of FC changing in value by using a derivative.

  • Derivative is

    • a contract whose value in local currency changes

    • with price movements in related commodity or financial instrument such as a foreign currency

  • Foreign Exchange (FX) Derivatives can include forward contracts, futures, swaps and options.

Gray, Salter & Radebaugh Chapter 2


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Derivatives Forward Contracts

  • Forward Contract

    • contract between a foreign currency trader and a client

    • for the future sale or purchase of foreign currency at a forward rate.

  • Forward Rate

    • contractual rate between the FX trader/client for the amount of currency A needed to acquire one unit of currency B at a fixed future date. (Table 2.1)

Gray, Salter & Radebaugh Chapter 2


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Derivatives - Forward Contracts

September 28, 2005

British Pound Per Dollar:

  • Spot .5560

  • One Month Forward .5847

  • Two Months Forward .5848

  • Three Months Forward .5848

Gray, Salter & Radebaugh Chapter 2


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DerivativesForward Contracts

  • Table 2.3 shows the impact of applying the information on forward exchange rates to the purchase of motherboards.

Gray, Salter & Radebaugh Chapter 2


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Table 2.3Cost of Motherboards Using Credit

Paying FC Two-Months After Purchase on September 28, 2005

Gray, Salter & Radebaugh Chapter 2


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Table 2.3Cost of Motherboards Using Credit

Paying FC Two-Months After Purchase on September 28, 2005

Gray, Salter & Radebaugh Chapter 2


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